How do I perform a sum-of-the-parts (SOTP) valuation using segment data?

Question

AcadiFi · Accepted Answer

Sum-of-the-parts (SOTP) valuation treats each business segment as a stand-alone entity, values it independently, and sums the results. It is essential for conglomerates where a single multiple does not capture the diverse business mix.

**When to Use SOTP:**
- Company operates in **multiple unrelated industries** (e.g., defense + healthcare + consumer)
- Segments have **very different growth rates, margins, and risk profiles**
- A conglomerate may trade at a discount to the sum of its parts (conglomerate discount)

**Step-by-Step Process:**

```mermaid
graph TD
    A["Identify Business
Segments"] --> B["Select Comparable
Pure-Play Peers"]
    B --> C["Apply Peer Multiple
to Segment Metric"]
    C --> D["Sum Segment Values"]
    D --> E["+/- Adjustments
(Net Debt, HQ Costs,
Minority Interest)"]
    E --> F["= SOTP
Equity Value"]
    style A fill:#c9a84c,color:#000
    style F fill:#10b981,color:#fff
```

**Worked Example — Meridian Holdings (fictional conglomerate):**

Meridian has three segments:

| Segment | Revenue ($M) | EBITDA ($M) | Comparable Pure-Play | Peer EV/EBITDA |
|---|---|---|---|---|
| Aerospace & Defense | $2,400 | $360 | Comparable defense firms | 12.0x |
| Healthcare Services | $1,800 | $270 | Comparable health services | 14.0x |
| Retail Consumer | $3,000 | $180 | Comparable retailers | 8.0x |

**Step 1: Value Each Segment**

| Segment | EBITDA | Multiple | Segment EV |
|---|---|---|---|
| Aerospace | $360M | 12.0x | $4,320M |
| Healthcare | $270M | 14.0x | $3,780M |
| Retail | $180M | 8.0x | $1,440M |
| **Total segment EV** | | | **$9,540M** |

**Step 2: Corporate Adjustments**

| Adjustment | Amount |
|---|---|
| Unallocated corporate overhead | -$90M EBITDA x 10x = -$900M |
| Net debt (total company) | -$2,200M |
| Minority interest in Healthcare sub | -$380M |
| Excess cash on balance sheet | +$150M |

**Step 3: SOTP Equity Value**

SOTP Equity Value = $9,540 - $900 - $2,200 - $380 + $150 = **$6,210M**

With 200M shares outstanding: SOTP value per share = **$31.05**

If Meridian trades at $26, the implied conglomerate discount = ($31.05 - $26) / $31.05 = **16.3%**

**Handling Key Complications:**

1. **Shared/Unallocated Costs:** Corporate headquarters costs that aren't assigned to segments must be valued separately (usually at a lower multiple or capitalized at the WACC).

2. **Inter-Segment Transactions:** Revenue between segments is eliminated in consolidation. Use external revenue only, or adjust EBITDA for internal transfer pricing effects.

3. **Conglomerate Discount:** SOTP often shows value above the trading price. This discount reflects complexity, management diversification, capital allocation inefficiency, and lack of focus. Typical discounts are 10-20%.

4. **Segment Multiple Selection:** Choose pure-play comparables that match the segment's **size, growth, and margin profile** — not just industry membership.

**Exam tip:** CFA Level II SOTP questions typically provide segment data and comparable multiples. The key is remembering to subtract unallocated costs and net debt to get equity value. Many candidates forget the corporate overhead adjustment.

Practice conglomerate valuation with our CFA Level II equity modules.

How do I perform a sum-of-the-parts (SOTP) valuation using segment data?

Master Level II with our CFA Course

Related Questions

Practice Questions