SOTP Meaning: Explanation of Sum-of-the-Parts Valuation & Model

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 owner of this website may be compensated in exchange for featured placement of certain sponsored products and services, or your clicking on links posted on this website. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). SuperMoney strives to provide a wide array of offers for our users, but our offers do not represent all financial services companies or products. Here, the comps-derived valuation is estimated using the “Low” and “High” end of the EV/EBITDA multiple ranges pulled from each segment’s peer group.

To create an SOTP model and valuation for GE, you would build out financial models for the individual components, including valuations if desired, and sum them together to arrive at the WholeCo level (combined company and entire business). In the General Electric scenario, it’s obvious that you will need different revenue and expense builds for each segment of the business. The company has (or had) offerings across aviation, healthcare, and financial services, among many others. Each of these will have totally different product offerings, revenue models, cost bases, and valuations. Sum-of-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.

Sum-of-the-parts valuation, also known as breakup value analysis, helps a company understand its true value. Once the firm values have all been calculated, the final step in our modeling exercise is to subtract net debt, which we assume to be $200m. The company consists of three segments – Segment A, B, and C – which are each valued at different multiples and operate in different industries. As implied by the name, SOTP entails valuing each underlying piece of a company separately and then adding them together, rather than valuing the entire company in aggregate using traditional means. From the total enterprise value (TEV), or “total firm value”, the company’s total net debt (gross debt less cash and equivalents) yields the implied equity value, i.e. the residual value attributable to only common shareholders.

1. These examples are programmatically compiled from various online sources to illustrate current usage of the word ‘stop.’ Any opinions expressed in the examples do not represent those of Merriam-Webster or its editors.
2. The owner of this website may be compensated in exchange for featured placement of certain sponsored products and services, or your clicking on links posted on this website.
3. Meanwhile, the DCF uses discounted future cash flows to value a business, project or segment.
4. 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).
5. As implied by the name, SOTP entails valuing each underlying piece of a company separately and then adding them together, rather than valuing the entire company in aggregate using traditional means.
6. (5) Deduct net debt and add/subtract other non-operating/financial items from the EV range to determine a range of equity values.

Any opinions, analyses, reviews or recommendations expressed here are those of the author’s alone, and have not been reviewed, approved or otherwise endorsed by any financial institution. All content on this website, including dictionary, thesaurus, literature, geography, and other reference data is for informational purposes only. This information should not be considered complete, up to date, and is not intended to be used in place of a visit, consultation, or advice of a legal, medical, or any other professional. Our SOTP modeling tutorial will start with some background details regarding the hypothetical company. We’ll now move to a modeling exercise, which you can access by filling out the form below.

We and our partners process data to provide:

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. 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. While both are valuation tools, the SOTP valuation can incorporate a discounted cash flow (DCF) valuation.

Create a free account to unlock this Template

In a normal model this would drive the value of the business in a proportional manner. However, investors and the market are much more excited about the faster growing, higher margin, scalable eCommerce business. This offering is more recent and has smaller revenue/EBITDA, https://1investing.in/ but will drive outsize value in a transaction. These examples are programmatically compiled from various online sources to illustrate current usage of the word ‘stop.’ Any opinions expressed in the examples do not represent those of Merriam-Webster or its editors.

An SOTP financial model of the document printing business will require analysis of foot traffic, print volumes, pricing by document type, cost of paper, rent, store employees, etc. Conversely, the eCommerce model will require a view on number of printers sold, price of the printers, cost of goods for the printers, warehouse space, online advertising expense, etc. Sum-of-the-parts, or SOTP, is a modeling and valuation approach frequently used by bankers and investors. This guide will provide background on the methodology, cover how to employ it yourself, and just give you a real explanation of the term if you’re simply curious about the meaning of SOTP.

Sum Of The Parts (SOTP) valuation is an approach to valuing a firm by separately assessing the value of each business segment or subsidiary and adding them up to get the total value of the firm. It can be used in conjunction with various valuation techniques such as Discounted Cash Flow (DCF) modeling and comparable company analysis. The sum-of-the-parts (SOTP) valuation involves valuing various business segments, and more valuations come with more inputs. As well, SOTP valuations do not take into account tax implications, notably the implications involved in a spinoff. 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.

As previewed above, SOTP refers to the practice of segmenting businesses into different parts for the purposes of valuation or financial modeling. When employing this tactic, your model will have different builds for revenue and expenses across each of the ‘Parts,’ ultimately building to segment-level EBITDAs. From there, the sum of each of the segment-level EBITDAs will generally equal the EBITDA of the whole company (WholeCo). 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. Sum of the Parts Analysis (SOTP), or “break-up analysis”, estimates the value of each business segment within a company separately, which are then added together to arrive at the company’s implied total enterprise value.

This may be a large conglomerate, such as General Electric, or a smaller company that has a few different offerings. For help on choosing the right valuation tool check out this guide to picking the right valuation method. Below is a list of examples of when this type of analysis is useful, and when it isn’t. Upon completing each division’s valuation, the values are added up to arrive at the total enterprise value (TEV).

Superb Owl Words

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. 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). Equity value is then calculated by deducting net debt and other non-operating adjustments.

At the highest level, your Excel tab structure will become more important in an SOTP model. With multiple parts, you’ll need to make sure that your model is easy to navigate, both for yourself and for anyone else who looks at your work. The last thing you need is a disorganized mess — you’ll hate your life and be way more likely to make mistakes. Now that we’ve covered types of businesses where an SOTP approach is helpful, we can now talk about a few practical applications. Note that SOTP is helpful and used frequently in standard M&A and capital raising transactions, but these specific scenarios are even more tailored to the approach. This dynamic is reflected by applying different multiples to each segment, say 8.0x EV / EBITDA for the physical printing and 15.0x EV / EBITDA for the eCommerce business.

(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. SOTP valuations are often used when the target has several operating divisions in unrelated industries, each with different risk profiles. For instance, a conglomerate like Berkshire Hathaway, which states the following business divisions in its annual report. The objective of SOTP is to value each part of the company separately and then add all the calculated values together.

Say the physical printing business is quite a bit bigger in terms of both revenue and EBITDA. The SOTP methodology is not limited to the largest multinational conglomerates (as some textbooks might have you believe). In reality it’s also hugely helpful for any business with disparate divisions or offerings. SOTP is commonly used when you’re modeling or valuing a company with different business lines.

If they don’t, it may take some deeper digging to get a breakdown of performance across different parts of the company. We’ll cover this in more detail later, but these segments are also helpful to piece together individual valuations. You can apply different sotp meaning multiples (such as EV / EBITDA or other) to the financials of each segment to arrive at an isolated value for that business line. When added together, the sum of the individual values will be your estimate of the value of the WholeCo business.

By multiplying the EV/EBITDA multiple by the corresponding EBITDA metric for each segment, we can determine the segment enterprise values. The next step is to calculate the enterprise value of each segment – both at the lower and upper end of the valuation range. Earlier-stage therapeutic assets, compared to those in the later stages of obtaining regulatory approval (or even commercialization), have a far lower probability of success and are therefore inherently riskier. Just don’t forget to subtract net debt and any non-operating items, then you’re good to go.