If you are new to investing, you may have heard of breakup value, but have no idea what it means. Sounds bad, huh? If there is much discussion about the breakup value of a company, it could mean that the company is having problems and is about to be sold off.
Simply put, the breakup value is what a company would be worth if its component parts were sold off and the liabilities were paid. For example, a certain company may have multiple subsidiary businesses operating in different industries. It may have a computer division, a food division, and an entertainment division. To determine the breakup value, you would need to figure out what the total assets are for each subsidiary, minus the total liabilities.
When a corporation or conglomerate is sold, sometimes it is sold for cash, or for stock in the acquiring company, or both. As an example, if company A is sold to company B, company A may receive a certain amount of cash for the sale, along with a certain amount of common stock in company B. Company B might decide to give all of the shareholders of company A a single share of stock in B for every four shares they have of A.
There are certain situations that may cause a company to be broken up. In the event it does split up, you should find out what the breakup value will be and how it will affect the value of your stock. We will now review each of the possible situations so that you will remember to consider the breakup value of a company before it is sold.
If the corporation is being poorly managed, the board of directors may decide to sell off the company to get something for their stock or to get stock in another company that has competent management and can help their stock grow in value.
Another situation that may arise is if one of the subsidiaries within the corporation has liquidity problems and can not be salvaged, the entire company is affected. As a result, the corporation may have to sell several of their businesses in order to restore the bottom line.
Another reason why a company could be broken up is if one of the divisions within the company, although it might be profitable, is holding back the growth of the other divisions. As a result, the board of directors may decide to sell off or destroy the part of the company that is holding it back so that it can experience much larger growth in its other sectors.
Also, if one of the businesses that the company owns is facing a potential lawsuit, the corporation may decide to break off that business so that the other profitable segments within the company are not financially vulnerable to any judgement rendered against the business that is about to be sued.
Breakup value does not always have to be a bad thing, it can also be used as a way to assess the financial strength of a company so that you can determine whether to hold on to its stock. If the share price of a stock is trading at a discount relative to its total assets minus liabilities, then you should probably hold on to the stock, unless the company has a negative outlook for the future.
I hope what you have learned here was helpful and informative. If you can not determine the breakup value of a company on your own, ask your portfolio manager or stockbroker to get the number for you. You should know this information even if the company in which you are invested is doing well, because if the company folds quickly, it will be hard to sell the stock. If that happens, it is possible that the only way that you will be able to recoup your investment is when the assets are liquidated so that the bondholders and shareholders can be compensated.