Multibusiness Valuation

Many valuations involve multibusiness companies whose futures depend on successful management of the portfolio of business units under their control. Multibusiness valuation is useful for several purposes, not the least of which is simply understanding the business. Strategic decisions for most multibusiness companies take place at the business-unit level. Thorough understanding of the company requires careful analysis of the threats and opportunities faced by each business unit. A company valuation built from separate valuations of business units provides much deeper insight than a company valuation that looks at the organization as a whole. The separate valuation of business units is at the heart of value-based management.

Multibusiness valuation is also useful for determining whether a company is more valuable as a combination of businesses or whether it is more valuable if the units are operated as stand-alone entities. It helps to create a clearer picture of headquarters costs and benefits since headquarters can be valued as if it were a separate cost center. The central question is usually whether the benefits of headquarters exceed the costs or if some of the extra layers of overhead can be trimmed.

The burden of proof is on management. The most current evidence suggests that conglomerates are valued lower by the market than comparable pure play companies. In the study most often cited on the subject, Berger and Ofek1 estimated the conglomerate discount to be about 15 percent, based on a study of more than 3,500 companies from 1986 to 1991. In a 1996 study, they also found that companies with larger conglomerate discounts were more likely to be taken over and broken up.2

1 P. Berger, and E. Ofek, "Diversification's Effect on Firm Value," Journal of Financial Economics, vol. 37 (1995), pp. 39-65.

2 P. Berger, and E. Ofek, "Bustup Takeovers of Value-Destroying Diversified Firms," The Journal of Finance, vol. 51, no. 4 (1996), pp. 1175-1200.

Valuing the Multibusiness Company

Valuing a multibusiness company is fundamentally the same as valuing a single-business company. What makes multibusiness valuation more complex is that each business unit has its own cash flows, capital structure, and cost of capital. In addition, business units may have shared cash flows and it may be hard to separate the costs and benefits of corporate headquarters.

Valuing a multibusiness company is somewhat like putting together building blocks. The value of the entire corporation is the sum of the value of the business units, plus nonoperating assets, less the unallocated costs of corporate headquarters. Unique issues in valuing a multibusiness company that were not discussed earlier in this book include:

• Defining business units and their cash flows.

• Determining cash flow costs and benefits of corporate headquarters.

• Estimating business-unit tax rates.

• Estimating business-unit capital structure and cost of capital.

• Estimating a discount rate for headquarters costs.

• Adding up the pieces to value the entire corporation. Defining Business Units and Their Cash Flows

In principle, a distinct business unit could be split off as a stand-alone business or sold to another company. A good rule of thumb is to define business units at the smallest practical level of aggregation. For example, a company may have a consumer products division that can be broken down into soap, toiletries, and detergents units. These are logically separable business units if they do not have interdependent means of production, distribution, or marketing.

Identifying business units and allocating cash flows among them is not always easy. Exhibit 14.1 illustrates a hypothetical company that markets

Exhibit 14.1 Business Units for a Hypothetical Company

0 0

Post a comment