Sum-of-the-Parts Valuation for Conglomerates

Why Conglomerates Need a Different Approach (The Valuation Problem)

A single P/E ratio cannot capture what a company is worth when it operates a software business, a healthcare division, and a consumer goods segment simultaneously. Each segment has different growth rates, capital intensity, and risk profiles. Applying one multiple to blended earnings destroys information.

The point is: Sum-of-the-parts (SOTP) valuation treats each business unit as a standalone entity, values it using appropriate methodology, and then combines the results.

This matters for:

• Conglomerates with distinct operating segments (think Berkshire Hathaway, General Electric, or Honeywell)
• Holding companies with minority stakes in other businesses
• Any company where segment disclosure reveals fundamentally different business models
• Activist investors arguing that breaking up a company unlocks value

The SOTP Formula and Process

Total Enterprise Value = Sum of (Segment Value) for all segments

Each segment gets valued using the methodology most appropriate for its industry:

The durable lesson: You must match the valuation method to the segment, not force every segment through the same multiple.

Step-by-Step SOTP Methodology

Step 1: Identify appropriate business segments

Start with segment reporting from the 10-K. Companies are required to disclose revenue, operating income, and assets by reportable segment. If the company has four segments but only breaks out three in filings (with the fourth aggregated into "Other"), you have a data problem.

Why this matters: Limited publicly available segment-level data is a major drawback of SOTP. You cannot value what you cannot measure.

Step 2: Select comparable companies for each segment

For a conglomerate with technology, healthcare, and consumer goods divisions:

• Technology segment: Compare to pure-play software companies trading at 28-40x EV/EBITDA
• Healthcare segment: Compare to medical device or pharma peers at 18-25x EV/EBITDA
• Consumer goods segment: Compare to FMCG companies at 12-15x EV/EBITDA

The point is: You are building three (or more) separate comparable company analyses, each with its own peer set.

Step 3: Perform standalone valuations

For each segment, calculate:

• Segment EBITDA or relevant metric (from company filings)
• Appropriate multiple (from comparable companies)
• Segment enterprise value = Metric x Multiple

Worked example:

Step 4: Handle corporate costs and net debt

Corporate overhead that is not allocated to segments must be valued (or deducted) separately. Common approaches:

• Capitalize unallocated corporate costs at a blended multiple
• Deduct them as a lump sum from total SOTP value
• Allocate them pro-rata to segments before valuing

Then subtract net debt (total debt minus cash) to arrive at equity value:

Equity Value = Total SOTP EV - Net Debt

Step 5: Consider the conglomerate discount

Here is where SOTP gets interesting. If your SOTP value is $23.3B but the company trades at $18.6B market cap (plus debt), the market is applying a 20% conglomerate discount.

The durable lesson: A discount is not an error in your model. It reflects the market's skepticism about management's ability to allocate capital efficiently across diverse businesses.

The Conglomerate Discount: Why It Exists

Conglomerate discount typically ranges from 10% to 30% (and can reach 50% in emerging markets like India).

The discount reflects:

• Complexity: Investors struggle to analyze diverse businesses
• Capital misallocation: Cash flow from profitable segments subsidizes underperformers
• Management distraction: Running multiple unrelated businesses dilutes focus
• Lack of pure-play alternative: Investors who want software exposure do not want it bundled with industrial equipment

Discount = 1 - (Market Cap / SOTP Value)

If SOTP = $100B and Market Cap = $80B: Discount = 1 - ($80B / $100B) = 20%

Why this matters: Activists target conglomerates trading at deep discounts because spinning off segments could unlock the hidden value.

Common Errors in SOTP Analysis

Error 1: Using the same multiple for all segments

A semiconductor segment at 27x EV/EBITDA and an oil refining segment at 5.5x EV/EBITDA cannot be valued at the company's blended 15x. This destroys information about where value actually resides.

The point is: Each segment deserves its own peer-derived multiple, even if this requires more work.

Error 2: Double-counting corporate costs

If corporate overhead is already allocated to segments in the filings, do not deduct it again. If it is unallocated, handle it once and only once.

Error 3: Ignoring synergy value

Some synergies between divisions would be lost in a spin-off scenario. Shared R&D, cross-selling, and centralized procurement create value that pure SOTP ignores.

The durable lesson: SOTP tells you what the pieces are worth separately. It does not tell you what they are worth together.

Error 4: Forgetting inter-segment transactions

If the technology segment sells software to the consumer goods segment, that revenue gets eliminated in consolidation. Valuing segment revenue without adjusting for inter-segment sales overstates the sum.

When SOTP Signals Opportunity

Scenario 1: Market cap far below SOTP value

If your SOTP analysis shows $100B of value but the stock trades at $70B equity value, either:

• The market knows something you do not (perhaps segment quality is deteriorating)
• The market is inefficient (potential opportunity)
• Your multiples are too aggressive (recalibrate)

Scenario 2: One segment dominates value

If 80% of SOTP value comes from one segment, the company is really a bet on that business. The other segments are noise (or distractions consuming management attention).

Why this matters: You should analyze that dominant segment with the depth of a pure-play analysis, not rely on blended conglomerate multiples.

Scenario 3: Hidden value in minority stakes

Conglomerates sometimes hold minority positions in other public companies. These stakes should be valued at market prices, not at book value carried on the balance sheet.

Worked Example: Hypothetical XYZ Corporation

Company overview:

• Technology Division: Cloud software, $50B segment value
• Healthcare Division: Medical devices, $30B segment value
• Consumer Goods Division: Packaged foods, $20B segment value
• Corporate overhead: $500M annually
• Net debt: $15B

SOTP calculation:

If market cap is $65B, the conglomerate discount is 18.75%.

The durable lesson: Whether that discount is justified depends on your view of management quality, capital allocation, and probability of restructuring.

When to Use SOTP (And When to Skip It)

SOTP works best when:

• Segments operate in fundamentally different industries
• The company provides detailed segment disclosure
• You have good comparable companies for each segment
• There is an activist thesis or restructuring possibility

SOTP is less useful when:

• Segments are highly integrated (synergies would be lost in separation)
• Segment data is too aggregated to be meaningful
• The company has one dominant segment (just value that segment)

Next Steps

1. Pick a conglomerate you follow and pull its segment disclosure from the latest 10-K. Identify which segments are large enough to matter.

2. For each material segment, find 3-5 pure-play comparables and calculate median EV/EBITDA multiples.

3. Build a simple SOTP model valuing each segment, deducting corporate costs and net debt.

4. Compare your SOTP equity value to the current market cap. Calculate the implied conglomerate discount (or premium).

5. Research whether any activists have taken positions. Their presentations often include SOTP analyses you can compare to your own.