One way investors can reduce risk is by buying assets trading at a discount to their intrinsic value. Several metrics can be used to determine the value of a business, including the price/earnings (p/e) and price-to-book value (p/b) ratios. Two others are Ebitda (earnings before interest, tax and amortisation) and Enterprise Value-to-Ebitda. The process can be more complex if a company has several operating divisions, which may have different attributes and prospects. The sum of private market valuations – the value that a trade or private-equity buyer would pay to acquire control – for each division may be higher than the valuation of the whole company, producing a discount to a “sum of the parts” valuation.
These discounts can narrow for several reasons. The stockmarket, driven by news or a shift in sentiment, can change its view of the valuation of the company; boards can unlock shareholder value by disposing of one or more divisions; or an investor identifies the opportunity and bids for the company. Below are three examples of smaller British firms that we believe are trading at notable discounts to their potential sum-of-the parts valuations.
A pharma group ripe for partition
Clinigen (Aim: CLIN), a pharmaceutical services and products group, has three divisions, built up through mergers and acquisitions (M&A) since its initial public offering in 2014. The shares trade at a forward p/e multiple of ten compared with a five-year average of 16. While there is some logic in keeping its three divisions together, each would appeal to different trade buyers. In our view, the current valuation is sufficiently attractive to interest a financial bidder, who could either integrate the divisions further or undertake a controlled break-up over time.
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Cash-rich chemicals
Elementis (LSE: ELM) is a speciality chemicals firm with three “core” divisions and several smaller business units. There is some customer overlap among the core businesses. The current rating of ten times forward earnings is depressed owing to the impact of Covid-19 on its sales and relatively high borrowings. But these will fall over time as the company is very cash-generative. Disposal of one of the smaller, non-core business units would accelerate debt reduction, simplify the story and support a share-price rerating.
Making money in a media niche
Euromoney Institutional Investor (LSE: ERM) is a niche media firm providing companies with financial information. It consists of three divisions. The jewel in its crown is its pricing division, which is based on a subscription model and has grown well over recent years. M&A multiples for similar assets imply that one of the other two divisions is being completely overlooked by the market. Euromoney postponed plans to sell the asset management division earlier this year, but we suspect it will revisit this decision.
Private equity has acquired similar business-media companies over the last couple of decades. The forward p/e is just over 14, assuming some recovery from the trough. We believe that Euromoney’s profit recovery will continue for several years and the stock could again trade at its peak of £15 within four years, implying ample upside from here. The company has no debt and the capacity to pay a good dividend.
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