While both are valuation tools, the SOTP valuation can incorporate a discounted cash flow (DCF) valuation. That is, valuing a segment of a company may be done with a DCF analysis. Meanwhile, the DCF uses discounted future cash flows to value a business, project or segment. The present value of expected future cash flows is discounted using a discount rate.
- This step was simple in this example because SunPower provided separate financial statements for Maxeon in its filings at the time of the spin-off.
- Too, SOTP valuations don’t consider tax suggestions, prominently the ramifications engaged with a spinoff.
- Note that the analysis will typically calculate the premium/discount to the current share price to suggest whether or not the public company is worth more or less when separated into its individual businesses.
- SunPower claims that it can reduce costs more effectively to compete with the Chinese solar PV companies that way, but we don’t have enough information to say for sure.
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This step was simple in this example because SunPower provided separate financial statements for Maxeon in its filings at the time of the spin-off. …but the installation and services segment could potentially trade at a much higher revenue multiple in the 4.0 – 5.0x range, in-line with comparable companies in that sector. (6) Divide by the sum of diluted shares outstanding to arrive at a range of equity values per diluted share. The sum-of-the-parts valuation (SOTP) is a course of esteeming a company by figuring out what its aggregate divisions would be worth on the off chance that they were veered off or acquired by another company. Since this is a spin-off that happened in real life, we want to reflect that SunPower shareholders received 0.125 Maxeon shares for each 1 SunPower share.
Example of How to Use the Sum-of-the-Parts Valuation – SOTP
We build sensitivity tables based on the Discount Rate, Terminal Growth Rate, and Terminal Multiple to determine the range of Implied Enterprise Values for each division. 2) 15-Year Projection Period – Since Maxeon, the lower-margin manufacturing company, will take years to become profitable, we extend the projections to 15 years rather than the normal period of 5-10 years. There’s no point backing into an Implied Share Price based on this comparable company analysis because we want the Implied Share Price for the entire company. To do so, ask yourself what the key value drivers are and whether or not one segment is driving/distorting the overall company value.
Learn More About the SOTP Valuation
The SOTP approach gives the analyst the liberty to choose an appropriate valuation that suits the particular sector in focus.
Illustration of How to Use the Sum-of-the-Parts Valuation – SOTP
By completing this spin-off, in other words, the total share count increased. In this SunPower / Maxeon example, a few steps are slightly different because it uses a real-life spin-off with proposed deal terms. When analysts track a large company like the energy giant Reliance Industries, they use a valuation method called sum of the parts or SOTP.
- Sum-of-the-parts valuation, otherwise called breakup value analysis, assists a company with grasping its true value.
- For this example we shall use a diversified company with three distinct businesses – a retailer with brick and mortar retail operations, real estate assets and online operations.
- 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.
- All 3 cases have the same sub-entities but the difference lies in the % of equity ownership of the parent within each entity.
- Equity value is then calculated by deducting net debt and other non-operating adjustments.
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The sum-of-the-parts (SOTP) valuation includes esteeming different business segments, and more valuations accompany more inputs. Too, SOTP valuations don’t consider tax suggestions, prominently the ramifications engaged with a spinoff. The valuation gives a scope of values to a company’s equity by conglomerating the standalone value of every one of its business units and showing up at a single total enterprise value (TEV).
What Is the Sum-of-the-Parts Valuation – SOTP?
You might skip this step for private companies because share prices are less meaningful there. The Sum-of-the-parts valuation is otherwise called the breakup value as it surveys what individual segments would be worth in the event that the company was broken up. Before we get started with each case, we shall calculate each company’s individual TEV. At the moment we are ignoring the % equity ownership of the parent within each entity. 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. And if the expenses for these services are not included in the separate financial statements, each division’s profitability might be overstated.
(5) Deduct net debt and add/subtract other non-operating/financial items from the EV range to determine a range of equity values. (4) Sum the values of each business segment, offset by corporate overhead, if appropriate. Sum-of-the-parts valuation, otherwise called breakup value analysis, assists a company with grasping its true value.
If a company is not controlled by the parent, then only the relevant equity investment is part of the parent’s total equity and hence its TEV. For this example we shall use a diversified company with three distinct businesses – a retailer with brick and mortar retail operations, real estate assets and online operations. All 3 cases have the same sub-entities but the difference lies in the % of equity ownership of the parent within each entity. It focuses on measuring the value of a business with distinctively different divisions or varying degrees of equity investments in other companies. By doing so you can achieve a more accurate valuation than only using earnings, the balance sheet and cash flows.
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The value of every business unit or segment is derived separately and not entirely set in stone by quite a few analysis methods. sotp meaning For instance, discounted cash flow (DCF) valuations, asset-based valuations and multiples valuations utilizing revenue, operating profit or profit margins are methods used to value a business segment. Sum-of-the-parts (“SOTP”) or “break-up” analysis provides a range of values for a company’s equity by summing the value of its individual business segments to arrive at the total enterprise value (EV).
Some would disagree with this adjustment and say that we should use only SunPower’s pre-spin-off share count. 1) We’ve already re-allocated corporate overhead costs appropriately in the separate models. Once we have all these individual pieces, we can put them together to estimate the value to shareholders if this spin-off proceeds as planned.
3) SunPower is already a self-sufficient company, and it will keep all its non-Maxeon divisions after the spin-off. There are no additional expenses to subtract because SunPower already has teams to handle functions such as accounting, IT, and HR. One problem with analyzing the divisions separately is that they often need services that the larger parent company provides. As a result, the company as separate entities could be worth more than the company as a single entity. But solar manufacturing accounted for only about half of SunPower’s revenue, so management and investors felt the company was undervalued. Before the spin-off, SunPower was a solar manufacturing, installation, and services company, but it had always traded at a significant discount to pure-play solar installation/services companies.
Equity value is then calculated by deducting net debt and other non-operating adjustments. For a company with different business segments, each segment is valued using ranges of trading and transaction multiples appropriate for that particular segment. Relevant multiples used for valuation, depending on the individual segment’s growth and profitability, may include revenue, EBITDA, EBIT, and net income. A DCF analysis for certain segments may also be a useful tool when forecasted segment results are available or estimable. The following spreadsheet demonstrates how to set up the sum-of-the-parts analysis for a publicly traded company. Note that the analysis will typically calculate the premium/discount to the current share price to suggest whether or not the public company is worth more or less when separated into its individual businesses.