Sum-Of-Parts Valuation

What is the 'Sum-Of-Parts Valuation'

The sum-of-parts valuation is a process of valuing a company by determining what its aggregate divisions would be worth if it was spun off or acquired by another company. The valuation provides a range of values for a company's equity by aggregating the standalone value of each of its business units and arriving at a single total enterprise value (TEV). The equity value is then derived by adjusting the company's net debt and other non-operating assets and expenses.

BREAKING DOWN 'Sum-Of-Parts Valuation'

Sum-of-parts valuation, also known as breakup value analysis, helps a company understand its true value. For example, you might hear that a young technology company is "worth more than the sum of its parts," meaning the value of the company's divisions could be worth more if they were sold to other companies. In situations such as this one, larger companies have the ability to take advantage of synergies and economies of scale unavailable to smaller companies, enabling them to maximize a division's profitability and unlock unrealized value.

The equation for the sum-of-parts valuation is not set in stone and is somewhat unique to the company's structure being evaluated. Traditionally, however, the equation is as follows: Equity value of a company = (value of segment A) + (value of segment B) + ... + (value of segment N) - (net debt) - (nonoperating liabilities) + (nonoperating assets)

An Example of the Sum-of-Parts Valuation

The value of each business unit or segment is derived using some sort of multiple indicative of the unit being valued. For example, discounted cash flow valuations, asset-based valuations and multiples valuations using revenue, operating profit or profit margins are all utilized to value a business segment.

If a business has a sales office that was specifically lucrative, for example, the company may use a revenue multiple to derive the future value of that business unit. Additionally, if a business has a technology component that also generated cash flow, it may use a net income multiple to derive that value.

For example, if a company is comprised of a technology business unit and a sales business unit, and if it has debt, its sum-of-parts valuation looks something like: (revenue generated by the sales business unit * 3) + (net income generated by the technology business unit * 5) - (debt).

Reasons to Use the Sum-of-Parts Valuation

The sum-of-parts valuation is most normally used to value a company comprised of business units in different industries with different valuation measures. It is possible to use this valuation to defend against a hostile takeover by proving the company is worth more as a sum of its parts. It is also possible to use this valuation in situations where a company is being revalued after a restructure.