Why We Cannot Infer Corporate Advantage from a Sum-of-the-Parts Analysis

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Do curso por University of London

Corporate Strategy

76 ratings

University of London

Corporate Strategy

76 ratings

Corporate strategy is the strategy a firm uses to compete across multiple businesses. Many small firms want to grow by entering new businesses. Many large firms already are in multiple businesses, e.g. a photo camera producer selling also sunglasses. We developed this course to help you make good corporate strategy decisions. Of the many decisions a firm has to make, corporate strategy decisions are among the most consequential. We will look at these key corporate strategy decisions: - Diversification: How and which businesses should your firm enter? - Divestiture: How and from which businesses should your firm exit? - Corporate HQ: How should we organize corporate headquarters to create value across the different businesses?

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Corporate Advantage

Welcome to week 1! This week, we introduce corporate strategy and its main goal: corporate advantage. To deepen our understanding of corporate strategy, we compare it with business strategy. We also cover sum-of-the-parts analysis, an often used technique to value multi-business firms, and we discuss how it relates to corporate advantage.

Conducting a Sum-of-the-parts Analysis12:47

Why We Cannot Infer Corporate Advantage from a Sum-of-the-Parts Analysis4:41

Conheça os instrutores

Bart Vanneste
Associate Professor
UCL School of Management

[MUSIC]

We've seen how to do sum-of-the-parts analysis, but what does it mean for

us corporate strategists?

Just a recap, in our sum-of-the-parts analysis,

we concluded that the equity value per share was 10 where as the price for

which the share was currently trading was only 9.

If you are a financial analyst, let's say you're working for Barclay's which

is actually right over there, you can look at these calculations as follows.

You can say actually the share price is cheap.

We calculated that it should be worth 10, but the actual price is only 9.

So in other words, you could say the share is undervalued.

Now if through our calculations we conclude that the share is very

undervalued, you might be willing to trade on that.

You could say I'm going to buy the share with the expectation or

hope that the share price will go up in the future.

But what about us, corporate strategies, what can we learn?

Can we learn anything about corporate advantage?

Here is the fundamentals of the sum-of-the-parts.

We calculated an Enterprise Value.

For each business of a multi-business firm,

we use multiples of single business peers,

that is enterprise value over earnings multiples.

Then we took the actual earnings of our own business and

multiply this to get enterprise value.

We repeated these steps for each of our businesses.

The sum of the businesses, that is the sum-of-the-parts,

then gives an enterprise value for the entire multi-business firm.

The formula shows a brief summary of this approach.

It comes down to a multiplication between our actual earnings of

the multibusiness firm, and multiples of single business peers.

Corporate advantage is when businesses owned together are worth

more than the businesses owned separately.

Thus we could say that corporate advantage compares the businesses when

part of a multi-business firm versus when they are single businesses instead.

This seems closely related to the comparison of a sum-of-the-parts analysis.

Can a sum-of-the-parts analysis tell something about corporate advantage?

No and yes. No, because earnings are taken as fixed.

It's the actual earnings of the businesses when owned jointly.

We take that as an input to our calculations.

From the calculations,

we can never infer what earnings would be like if owned separately.

Thus, a sum-of-the-parts analysis can not tell us what

our businesses would be worth if owned separately.

However, a sum-of-the-parts analysis can tell you whether the market values,

a given level of earnings, differently for

your multi-business firm than for comparable single business firms.

Let me explain.

If we find that the sum-of-the-parts is higher than the share price,

it basically means that the multiple for which the single business peers

are trading is higher than the multiple for which you are trading.

This implies that the market values a $1 earning of your

single business peers more than a $1 earning of your multibusiness firm.

One reason for this difference,

could be that the market does not understand your corporate strategy.

And in particular, how you would create value across your different businesses.

In summary, a sum-of-the-parts can provide

insight on the multiple, but not on the earnings.

Thus, a sum-of-the-parts analysis

cannot tell us whether we have corporate advantage.

However, it can give us an indication of how well the market values our earnings.

And in effect that means, how well the market appreciates and

understands our corporate strategy.

[MUSIC].

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