Sum‑of‑the‑Parts (SOTP) Valuation

Sum‑of‑the‑Parts (SOTP) valuation estimates a company’s worth by valuing each business unit independently and aggregating those values. It is most useful for conglomerates or diversified companies where different divisions operate in distinct industries and are likely to be valued using different methods.

Core idea

• Value each operating segment as if it were a standalone business.
• Combine segment values to produce a total enterprise value (TEV).
• Adjust TEV for net debt and non‑operating items to arrive at equity value.

Key formulae

• Total Enterprise Value (TEV) = Σ (Enterprise Value of each segment)
• Equity Value = TEV − Net Debt − Non‑operating Liabilities + Non‑operating Assets

Or, written compactly:
Equity Value = Σ Segment Values − Net Debt − Non‑operating Liabilities + Non‑operating Assets

How to calculate SOTP — step by step

1. Identify segments to value separately (business lines, geographies, joint ventures).
2. Choose an appropriate valuation method for each segment:
3. Discounted Cash Flow (DCF) for predictable cash‑flow businesses.
4. Market multiples (EV/EBIT, EV/EBITDA, P/E) using comparable peers.
5. Asset‑based valuation for asset‑heavy or distressed segments.
6. Value each segment on a consistent basis (e.g., enterprise value or equity value).
7. Sum the segment enterprise values to get TEV.
8. Adjust for corporate and non‑operating items:
9. Subtract consolidated net debt to move from TEV to equity value.
10. Add/subtract non‑operating assets or liabilities (investments, pension deficits, minority interests).
11. Reconcile and sanity‑check results (compare implied multiples, consider synergies).

Practical example

A company splits into three divisions:
– Aerospace: $107 billion
– Elevators: $36 billion
– Building systems: $52 billion

TEV = $107B + $36B + $52B = $194B
Assume net debt and other adjustments = $39B

Equity Value = $194B − $39B = $155B

(This illustrates how segment valuations combine and how debt/other items reduce the equity value.)

When to use SOTP

• Conglomerates with diverse operations.
• Companies undergoing restructuring or potential spin‑offs.
• Situations where parts may be worth more separately than together.
• Defense against hostile takeovers (demonstrating breakup value).

Insights SOTP can reveal

• Hidden value: segments undervalued by the market when consolidated.
• Optimal corporate actions: spin‑offs, divestitures, or restructurings that can unlock value.
• Valuation mismatch across industries: different required multiples or discount rates per segment.

Limitations and challenges

• Complexity: more segments mean more assumptions and inputs.
• Synergies: SOTP may ignore positive synergies that make the whole worth more than parts.
• Tax and transaction costs: spin‑offs or breakups often trigger taxes and fees that SOTP may not reflect.
• Allocation subjectivity: assigning centralized costs, corporate overhead, and shared assets can be ambiguous.
• Comparable availability: finding appropriate peers and multiples for each segment can be difficult.
• Timing and market conditions: market multiples change, affecting comparability.

Practical tips

• Value segments on the same basis (preferably enterprise value) to avoid double counting.
• Adjust for corporate overhead and intra‑segment transfers.
• Use a range of methods (DCF and multiples) and present sensitivity analyses.
• Include tax and transaction cost estimates if evaluating actual breakup scenarios.
• Cross‑check with market capitalization and comparable transactions.

Bottom line

SOTP is a powerful tool to reveal the standalone value of diverse business units and to assess whether a firm is worth more together or broken up. It provides clarity for strategic decisions—mergers, divestitures, spin‑offs, and takeover defenses—but requires careful treatment of synergies, taxes, and allocation of corporate items. When deployed with consistent assumptions and sensitivity analysis, SOTP offers a nuanced view of a company’s intrinsic value.