2.2.7 Sum of the Parts

Welcome to On Judgement. Harbour makes equipment and services an installed customer base. Would selling the divisions separately necessarily make shareholders richer? Take a first view. You can change it when you have considered the evidence.

A group can contain operations with different growth, margins, risks and capital needs. SOTP values those operations using methods suitable to each, then reconciles to the relevant group claim. It is not reserved for giant conglomerates. Revenue is not a substitute for profit when allocating a profit multiple, and internal transfers must not be counted as external group earnings twice.

Divisional values can overstate the group if recurring central costs are omitted. Deduct a justified value for those costs where they are not already included. Deal with debt, cash, pensions, minority claims and non-operating assets consistently. This exercise excludes additional claims and assumes a stated central-cost value. Do not capitalise central costs and also deduct the same costs again within the divisional estimates.

A group can trade below an analyst’s sum because of complexity, capital allocation concerns, costs, financing or simply different assumptions. An attractive standalone multiple is not a cash offer for the division. Separation may lose shared customer relationships, technology, purchasing scale or distribution. Compare the integrated strategy with credible alternatives rather than assume that a theoretical gap can be collected immediately.

SOTP can inform valuation while the business remains integrated. A separation proposal needs after-cost proceeds, tax, execution, funding and dis-synergies investigated. Directors’ duties are jurisdiction-specific and cannot be reduced here to a requirement to accept the largest headline estimate. This classroom committee assesses a business case, not legal compliance or a real transaction.

Let's work through Harbour’s two divisions · £m. Equipment divisional EBITDA is 28 and service EBITDA 16, both before central costs. Annual central expense is 2, so consolidated EBITDA is 42. Use invented multiples 5x and 6x respectively. Deduct a separately assumed £20m present value of central costs. Net debt is 20; shares 20m. Pause here and try the calculation or reasoning before continuing.

Equipment EV = 28 × 5 = 140; service EV = 16 × 6 = 96. Divisional EV sum = 236; after central costs = 236 − 20 = 216. Equity = 216 − 20 net debt = 196; value per share = 196/20 = £9.80. Using equipment 4.5–5.5x and service 5.5–6.5x with the same deductions gives £8.70–£10.90 per share.

The £20m central-cost deduction and £20m net-debt deduction are different items that happen to have the same amount. The estimate does not include actual separation proceeds or costs.

Now try the choices in this lesson. If your answer changes, identify the reason. Separate segment valuation from a claim that breakup creates value. Use the case activities to put the idea into your own words, and return to the evidence when more than one conclusion is defensible.