Is the Sum Greater than the Whole?

Sum of the parts and how it led me astray

I used to love these phrases in investment write ups: “… and at this price, if you invest in WhizCo, all you are paying for is the core business and you get their new startup division for free!” I was like a fly to honey. I mean, who can resist free, right? Right?

Now, I’ll tell you who can resist free: I can.

Maybe “you get what you pay for” is a better first principal.

Like many investing concepts, it has intuitive appeal. Imagine a company consisting of several divisions. Maybe some of them are good, maybe some of them are not so good, and you can successfully value each piece - using say, the discounted cash flow model! Then you add all the pieces up, and it is worth significantly more than where the company is currently trading - bingo! Margin of Safety! Money, money. They call this a sum-of-the-parts investment thesis or SOTP. And if used correctly it can help you find overlooked value opportunities in sometimes confusing, conglomerate type companies. Purchase at a discount to sum of the parts, and you have found a good Margin of Safety.

I found; it usually doesn’t work that way for me.

By way of example, many years back, I successfully invested in a company called Mobile Mini (it later merged with a company called WillScot and it is still publicly traded). I made some dollars on the investment and was looking around for a likey-likey investment thesis in the same modular storage space. I stumbled upon a company called Arts-Way. It’s still around. It does basically the same thing. And it is still, based on my recent 30 seconds of analysis, a SOTP play.

When I looked at the company years ago, it had a modular building component, which I was interested in, a pressurized vessel business (think propane tanks and the like) and an agricultural manufacturing business - which was the biggest. All the different divisions seemed to have some coherence; they were all light-to-medium manufacturing businesses. I dutifully did my SOTP analysis, determined it possessed a good MOS and bought some. Even though the modular building business, which is what originally attracted me, was one of the smaller divisions. But no matter. At the price I was paying, I was getting the modular building division for free! I owned it for a year or so, and I distinctly remember listening to one of the quarterly calls and being regaled with the current state of the sugar beet business. You see, one of their largest products was used for sugar beet harvesting. I thought something to the effect, “I don’t give two !%%!$@’s about sugar beet harvesters! Why do I own this thing!” I promptly sold.

Although I remember this clearly, I’m not sure it prompted a lot of introspection at the time. In hindsight, it did mark the start of a gradual shift from just concentrating on strict “value” or discount to some hypothetical intrinsic value calculation to focusing more on the attributes of the core operating business. It also taught me another valuable lesson that I carry with me to this day. The most important component of any SOTP thesis: management.

It really does no good to see a SOTP story that management is not interested in unlocking. Often the management’s interests are not aligned with shareholders. It is the rare CEO that will – of their own accord – sell off a piece of their business and efficiently return the freed-up capital to the shareholders. This involves making the company, their kingdom, smaller. Frequently it requires the presence of an activist to come in and highlight the issue and force management to change, or even, to change management, so that the value can be unlocked. Now whenever I see a SOTP opportunity, I don’t run out and do valuation work, I look at the management and their incentives. I find that is the key to unlock.

For over 10 years now, I occasionally look at a small company that makes servomotors. They also have a cutlery division. It is a sum-of-the-parts story. I’m proud to say, I have never bought it…

A Beautiful Sum Of The Parts Story