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It is used to deduct the valuation of a firm where each subsidiary or business unit is valued separately and then all are added to get the total value.
It provides a range of values for the company’s equity calculated from the summation of the values of its operating segments to get the total firm value.
Most large firms have diversified business segments and separate valuation for - each unit and the headquarter.
The method of valuation works by parts and adds up to get the SOTP, which is used by stock market analysts and the companies themselves.
It applies multiples derived from comparable publicly traded companies to the operating metrics of each operating unit. It is often used to make a case for the divestiture of one or more businesses.
For a business, investing solutions for each segment are valued using a range of trading and transaction multiples, which is suitable for the particular segment.
The relevant multiples are used for valuation and it depends on the individual segment’s profitability and growth, which may include EBITDA, revenue, and net income.
The SOTP or break-up analysis adds segment A and segment B and other segments, and then the net debt and the non-operating assets/liabilities are deducted, to get the equity value of the company firm.
Pros and Cons
The analysis is used in different types of businesses having different company valuation methods and variables. The method helps large firms to benefit from the economies of scale and synergies to get the highest profitability and it can also be used to defend against a hostile takeover.
It can be used to revalue the firm after restructuring. The drawback of the method is that it does not take into account the tax implications.
Further, the reliability of this method depends on the level of comparability of the selected publicly traded companies/ units. It does not value the combination of businesses and it may not be able to provide results if the financial metrics of any of the subsidiaries are not available.
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