What Is the Sum-of-the-Parts Valuation – SOTP?
The sum-of-the-parts valuation (SOTP) is a process of valuing a company by determining what its aggregate divisions would be worth if they were 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.
How to Calculate Sum-of-the-Parts Valuation – SOTP
The value of each business unit or segment is derived separately and can be determined by any number of analysis methods. For example, discounted cash flow (DCF) valuations, asset-based valuations and multiples valuations using revenue, operating profit or profit margins are methods utilized to value a business segment.
What Does the SOTP Tell You?
Sum-of-the-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 SOTP valuation is most commonly used to value a company comprised of business units in different industries since valuation methods differ across industries depending on the nature of revenue. 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 restructuring.