Sum of parts valuation

A company may have businesses that are too varied for the application of a single valuation method or ratio to all its businesses to be useful. This means, for example, that applying EV/EBITDA to total EBITDA, or using CAPM with a single beta may be not be the right approach.

The solution is to value the different parts of the business separately and add the values of the different parts of the business together. This is a sum of parts valuation.

A sum of parts valuation may be used to adjust a valuation method to suit different parts of a business. For example, a company may have a growth business that deserves a high PE and a mature business that deserves a low PE. A cyclical business may require a higher discount rate when doing a DCF.

A sum of parts valuation also allows different valuation methods to be used for different parts. Consider a company that has three businesses:

  1. a subsidiary in which it owns a 50% stake and which is separately listed,
  2. a new business in which it has invested heavily but which is not expected to become profitable for several years,
  3. a mature, stable, defensive business that produces dependable cash flows.

Applying a single PE or EV/EBITDA to this business would be difficult. A possible approach using a sum of parts would be:

  1. Value the separately listed subsidiary using the market value of its shares, possibly with a premium for the fact that it is a controlling interest.
  2. Use a DCF for the new start-up.
  3. Use an EV/EBITDA for the stable business

Depending on how this is applied this will give you three numbers that can be added together to give an EV for the whole company.

It may be necessary to adjust the total (usually by applying a smallish discount) for the effect of the fact that the businesses are in fact combined.

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