Sum-of-Parts Valuation: Valuing Diversified Companies

Introduction: When Whole ≠ Sum of Parts

“This company has a banking arm, an IT services business, and real estate holdings. How do I value it?”

Sum-of-Parts (SOTP) valuation addresses exactly this challenge. When a company operates in multiple distinct businesses, valuing it as one entity using a single multiple often doesn’t capture its true value. SOTP values each business segment separately and adds them together.

The SOTP Concept

Why SOTP Is Needed

Problem with Traditional Valuation:

A diversified company with IT services and manufacturing can’t be valued at one IT multiple or one manufacturing multiple. Each business deserves its own valuation.

Basic Formula

$$Total\ Value = \sum Value\ of\ Individual\ Segments$$

Or more specifically: $$EV_{Total} = EV_1 + EV_2 + … + EV_n + Net\ Cash - Corporate\ Costs$$

When to Use SOTP

• Conglomerates with diverse businesses
• Companies with valuable subsidiaries
• Spin-off analysis
• Breakup/restructuring scenarios
• Hidden value identification

SOTP Methodology

Step 1: Identify Distinct Segments

Segment Characteristics:

• Different business models
• Different markets
• Different growth profiles
• Different risk characteristics
• Separate management teams (often)

Indian Conglomerate Example:

Step 2: Value Each Segment

Valuation Methods by Segment:

Step 3: Select Appropriate Multiples

Use Segment-Specific Comparables:

IT Services:

• Comparable companies: TCS, Infosys, Wipro
• Multiple range: 12-18x EV/EBITDA

Steel:

• Comparable companies: JSW Steel, Tata Steel
• Multiple range: 5-8x EV/EBITDA

Power:

• Comparable companies: NTPC, Tata Power
• Multiple range: 6-10x EV/EBITDA

Step 4: Calculate Segment Values

Example Calculation:

Step 5: Adjust for Corporate Items

Add:

• Cash and equivalents
• Marketable securities
• Real estate (not in segments)
• Listed investments (mark-to-market)

Subtract:

• Debt (at holding company level)
• Corporate overhead (capitalize)
• Minority interests

Example:

Conglomerate Discount

What Is Conglomerate Discount?

The market often values diversified companies at less than their SOTP value.

$$Conglomerate\ Discount = \frac{SOTP\ Value - Market\ Cap}{SOTP\ Value} \times 100$$

Reasons for Discount

1. Complexity:

• Harder for investors to understand
• Less analyst coverage per segment

2. Capital Allocation:

• Cross-subsidization concerns
• Suboptimal investment decisions
• Empire building by management

3. Operational Inefficiency:

• Bureaucracy
• Lack of focus
• Higher corporate overhead

4. Governance Issues:

• Complex ownership structures
• Related party transactions
• Minority shareholder concerns

Typical Discounts

Indian conglomerates often trade at higher discounts due to:

• Complex group structures
• Related party concerns
• Promoter holdings
• Historical governance issues

Calculating Implied Discount

Example:

• SOTP Value: ₹210,640 crore
• Current Market Cap: ₹150,000 crore

$$Discount = \frac{210,640 - 150,000}{210,640} = 28.8%$$

Valuing Listed Subsidiaries

Mark-to-Market Approach

When a company owns stakes in listed companies:

$$Stake\ Value = Shares\ Owned \times Current\ Share\ Price$$

Example: Holding Company

Parent Company owns:

Holding Company Discount

Additional discount applied because:

• Tax leakage on dividends
• Inability to realize full value immediately
• Governance/complexity
• Liquidity of holding company shares

Typical holding company discount: 20-50%

Special Considerations

Intercompany Transactions

Eliminate double-counting:

• Transfer pricing
• Management fees
• Brand royalties
• Intercompany loans

Shared Services

Allocate corporate costs:

• Finance function
• HR
• IT infrastructure
• Legal and compliance

Methods:

• Revenue-based allocation
• Asset-based allocation
• Headcount-based allocation

Synergies Between Segments

May exist value from:

• Cross-selling
• Shared infrastructure
• Brand leverage
• Tax optimization

Consider: If segments were separate, some synergies would be lost.

Minority Interests

Treatment:

• Value 100% of segment
• Subtract minority share as adjustment
• Or value only proportional ownership

SOTP for Different Company Types

Industrial Conglomerates

Indian Examples: Tata Group companies, Reliance Industries, Adani Group

Approach:

• Value each industrial segment
• Add investments in listed companies
• Significant corporate adjustments

Financial Holding Companies

Indian Examples: HDFC Ltd (pre-merger), Bajaj Holdings

Approach:

• Value banking subsidiary
• Value insurance subsidiary
• Value other financial services
• Mark listed investments to market

IT Companies with Products and Services

Indian Examples: Infosys (services + products), HCL Tech

Approach:

• Value services business on services multiples
• Value products business separately
• May be combined or separated

Real Estate + Other Businesses

Approach:

• Value operating business on operating metrics
• Value real estate separately (NAV or market value)
• Often significant hidden value in land

SOTP Example: Comprehensive Case

Company: Diversified Industries Ltd

Business Overview:

• Heavy Engineering (core business)
• Consumer Products (profitable division)
• Real Estate (land bank)
• 35% stake in Listed Finance Co

Segment Financials (₹ crore):

Step 1: Value Operating Segments

Step 2: Value Real Estate

Land Holdings:

• Location: Major metros
• Total area: 500 acres
• Market value: ₹10 crore per acre
• Gross value: ₹5,000 crore
• Less: Development costs, time value
• Net NAV: ₹3,500 crore

Step 3: Value Listed Investment

35% stake in Finance Co:

• Finance Co market cap: ₹50,000 crore
• Stake value: ₹17,500 crore

Step 4: Corporate Adjustments

Step 5: Compare to Market

• Current market cap: ₹32,000 crore
• SOTP value: ₹45,900 crore
• Implied discount: 30%

Interpretation

Is the discount justified?

Arguments for higher discount:

• Complex structure
• Corporate governance concerns
• Capital allocation track record

Arguments for lower discount:

• Strong individual businesses
• Improving governance
• Potential for value unlocking

Value Unlocking Strategies

Spin-offs

Separate business units into standalone companies:

• Each gets dedicated management
• Focused investor base
• Appropriate valuation multiple

Indian Example: Jio-Reliance Retail separation from core business

IPO of Subsidiaries

List subsidiary separately:

• Establishes market value
• Provides liquidity
• Reduces holding discount

Asset Sales

Sell non-core businesses:

• Focus remaining business
• Reduce complexity
• Return cash to shareholders

Restructuring

Simplify corporate structure:

• Merge overlapping entities
• Eliminate circular holdings
• Improve governance

Key Takeaways

1. SOTP values parts separately – Then aggregates
2. Use segment-specific multiples – Not one-size-fits-all
3. Conglomerate discount exists – 20-40% in India common
4. Mark listed investments to market – Add as investment value
5. Adjust for corporate items – Debt, cash, overhead, minorities
6. Compare to trading price – Identify discount/premium
7. Consider value unlocking – Spin-offs, sales, restructuring

Disclaimer

This article is for educational purposes only. SOTP valuation requires detailed analysis and professional judgment. Consult qualified financial professionals for actual valuations. This is not investment advice.

Frequently Asked Questions

Q: Why do conglomerates trade at a discount? A: Complexity, capital allocation concerns, governance issues, and lack of focus make investors discount these companies. They prefer “pure play” investments.

Q: How do I value private subsidiaries? A: Use comparable company analysis or DCF based on available segment information. Less precision is expected for non-listed entities.

Q: Should I apply holding company discount separately? A: Yes, for pure holding companies. For operating conglomerates with some listed stakes, a combined conglomerate discount is more common.

Q: What if segment information isn’t disclosed? A: Use segment revenue if EBITDA isn’t available, estimate margins based on comparables, or value at consolidated level with adjustments.

Q: Can SOTP be higher than market value? A: Yes, this indicates a conglomerate discount. It may signal undervaluation or reflect legitimate concerns about the company structure.

SOTP is like valuing a property portfolio—you value each property individually based on its type, location, and condition, then add them up. The total might be more than what someone would pay for the entire portfolio at once, because managing many properties is more complex than owning one.