Breakup Value

The breakup value is the sum-of-parts value of a publicly traded company. Investors derive this value by analyzing each business segment of a company independently. Breakup value is usually applied to large cap stocks that are likely to operate in several different markets or industries. Investors may decide to conduct a more in-depth breakup value analysis if the company’s market cap is less than the breakup value for a prolonged period of time.

If a company is performing poorly, or if the stock has not kept up to the perceived level of "full value," investors may call for the company to be split apart, with proceeds returned to investors as cash, stock in spun-off companies, or a combination of both.

Investors can also calculate a breakup value on a perfectly healthy company as a way to determine a potential floor for the stock and/or a potential entry point for a prospective buyer. In order to accurately calculate a company's breakup value, detailed data is needed on the company’s revenue, earnings and cash flows for each distinct operating unit. From there, relative valuations, based on publicly-traded industry peers, can help to derive a value for the segment.

Analysts value each part of a company in a breakup value analysis. One way to do this is by relative valuations, which take into account the company’s industry peers to determine how the company is stacking up. Using multiples, such as price-to-earnings (P/E), forward P/E, price-to-sales (P/S), price-to-book (P/B), and price to free cash flow, analysts can determine how business segments are performing to similar entities.

Analysts may also use an intrinsic valuation model, such as a discounted cash flows or DCF model. In this scenario, analysts use the business segment’s future free cash flow projections and discounts them, using a required annual rate, to arrive at present value estimate.

A DCF is calculated as:

DCF = [CF1 / (1+r)1] + [CF2 / (1+r)2] + ... + [CFn / (1+r)n]

CF = Cash Flow

r = discount rate (WACC)

Other business valuation methods include market capitalization, which involves a simple calculation of multiplying a company’s share price by its total number of shares outstanding. In addition, the times revenue method relies on a stream of revenues generated over a certain period of time, to which an analyst applies a specific multiplier, derived from the industry and economic environment. For example, a tech company in a high growth industry may be valued at 3x revenue, while a less hyped service firm may be valued at 0.5x revenue.