391 19 Valuation by Parts Up to this point, our analysis has focused on single-business companies. But many large companies have multiple business units, each competing in seg- ments with different economic characteristics. For instance, Anglo-Dutch Unilever competes in food and refreshments, personal products, and home- care products. Even so-called pure-play companies, such as Vodafone (mobile telecommunication services) and Amazon (online retail), often have a wide variety of underlying geographical and category segments. This is not just the case for large companies: consider the local bicycle shop that also has an online sales channel. If the economics of a company’s segments are different, you will generate more insights by valuing each segment and adding them up to estimate the value of the entire company. Trying to value the entire company as a single en- terprise will not provide much understanding, and your final valuation may be way off the mark. Consider a simple case where a faster-growing segment has lower returns on capital than a slower-growing segment. If both segments maintain their return on invested capital (ROIC), the corporate ROIC would decline as the weights of the different segments change, while the corporate growth rate would steadily increase. Valuing by parts generates better valuation estimates and deeper insights into where and how the company is generating value. That is why it is stan- dard practice in industry-leading companies and among sophisticated inves- tors. This chapter explains four critical steps for valuing a company by its parts: 1. Understanding the mechanics of and insights from valuing a company by the sum of its parts 2. Building financial statements by business unit—based on incomplete information, if necessary 392  Valuation by Parts 3. Estimating the weighted average cost of capital (WACC) by business unit 4. Testing the value based on multiples of peers The Mechanics of Valuing by Parts The most effective way to explore the mechanics of valuing by parts and the insights that can result is to work through a valuation. Exhibit 19.1 details the key financials, value drivers, valuation results, and multiples for each part of ConsumerCo, a hypothetical business. Its parts are four business units, a financial subsidiary, and a nonconsolidated joint venture. To simplify, we kept all future returns and growth rates constant at 2020 levels for each business unit. All of ConsumerCo’s businesses sell products for personal care, but their economics differ widely. The key financials and value drivers in Exhibit 19.1 make this clear. The company’s primary business unit, branded consumer products, sells well-known brands in personal care (mainly skin creams, shav- ing creams, and toothpaste). It generates $2.0 billion in revenues at returns well above its 8.6 percent cost of capital, but mainly in slow-growth, mature markets. Private label, the next-largest business at $1.5 billion in revenues, produces for large discount chains selling products under their own names. This unit is growing faster than the branded-products business, but at far lower returns on capital that barely meet its cost of capital. The devices business, with $1.25 billion in revenues, sells electronic de- vices for personal care, such as sun beds, shavers, and toothbrushes, at a very healthy 18.1 percent return on capital, paired with high growth rates. The newly developed organic-products business has $750 million in revenues in premium products made with natural materials. It generates both the highest returns and the highest growth. The $83 million in annual costs for running the corporate center are shown as a separate business unit. Finally, internal revenues, earnings before interest, taxes, and amortization (EBITA), and in- vested capital are eliminated in the consolidation of ConsumerCo’s financials, as the branded-products business buys components from the private-label business unit. The discounted-cash-flow (DCF) valuation results and multiples in Ex- hibit 19.1 reflect these differences in size, growth, and ROIC across the businesses. Not surprisingly, the high returns and large scale in branded products lead to the largest valuation ($5,188 million), and the implied mul- tiple of enterprise value (EV) to net operating profit after taxes (NOPAT) is 16.0 times. The private-label business generates almost a third of the com- pany’s revenues but contributes only around 10 percent of value ($1,128 mil- lion) because of its low returns on capital. Despite its higher growth rate, its 393 Exhibit 19.1  ConsumerCo: Valuation Summary, January 2020 Key financials $ million Value drivers % Valuation $ million Multiples Revenue EBITA Invested capital Revenue growth Operating margin ROIC WACC DCF value EV/ NOPAT EV/ NOPAT 2020 2020 2020 2018 2019 2020 2020–25 2018 2019 2020 2020–25 2018 2019 2020 2020–25 Peers Branded products 2,000 500 1,600 1.5 2.5 3.0 3.0 23.0 24.3 25.0 25.0 19.7 19.9 20.3 20.3 8.6 5.188 16.0 15.6 Private label 1,500 143 900 4.6 4.7 5.0 5.0 7.7 8.5 9.5 9.5 8.5 9.3 10.3 10.3 9.1 1,128 12.2 11.7 Devices 1,250 156 563 7.1 7.3 7.5 7.5 11.2 12.0 12.5 12.5 15.8 17.1 18.1 18.1 10.1 1,474 14.5 14.0 Organic products 750 206 488 9.3 9.5 10.0 10.0 27.6 27.3 27.5 27.5 27.6 27.5 27.5 27.5 8.6 3,440 25.7 24.5 Corporate center – (83) 806 4.4 5.0 5.4 5.61 9.1 (1,123) 20.9 – Eliminations (500) (2) (50) – – – Total operations 5,000 920 4,306 4.5 5.1 5.5 5.7 17.7 18.4 18.4 18.3 12.6 13.2 13.9 14.7 10,107 16.9 Customer finance 10.52 1503 12.12 12.02 Cosmetics joint venture 9.1 6094 17.6 17.0 Excess cash 250 Gross enterprise value 11,117 Debt (1,941)5 Equity value 9,175 1 For HQ: growth of HQ costs. 2 For customer finance: P/E cost of equity. 3 At equity value, net of debt, in customer finance. 4 Equity value of minority stake in cosmetics joint venture. 5 Excluding debt in customer finance: $1,038 million.