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Imagine a company sold a 10% stake in one of its assets to a 3rd party for $100 million. It would be fair to assume that the asset is worth $1 billion.

If that company had 200 million shares issued, and were trading at a price of $4/share, then its market capitalization would be $800 million.

Does that mean the share is undervalued, because its market cap is only $800 million but yet by outsiders/a 3rd party transaction, one of its assets alone is worth $1 billion? Hence, the share price should be worth at least $5/share? Else, what am I missing?

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You haven't mentioned how much debt your example company has. Rarely does a company not carry any kind of debt (credit facilities, outstanding bonds or debentures, accounts payable, etc.) Might it owe, for instance, $1B in outstanding loans or bonds?

Looking at debt too is critically important if you want to conduct the kind of analysis you're talking about. Consider that the fundamental accounting equation says:

Assets = Liabilities (debt) + Capital (equity)

or,

Assets - Liabilities (debt) = Capital (equity)

But in your example you're assuming the assets and equity ought to be equal, discounting the possibility of debt. Debt changes everything. You need to look at the value of the net assets of the company (i.e. subtracting the debt), not just the value of its assets alone.

Shareholders are residual claimants on the assets of the company, i.e. after all debt claims have been satisfied. This means the government (taxes owed), the bank (loans to repay), and bondholders are due their payback before determining what is leftover for the shareholders.

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    +1 for the accounting axiom. Don't forget that market capitalization is only common stock. Any preferred stock (which sometimes is issued like debt) is also going to reflect enterprise value but won't show up in market cap.
    – THEAO
    Jan 13, 2014 at 16:17
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Look at Price/book value and there are more than a few stocks that may have a P/B under 1 so this does happen. There are at least a couple of other factors you aren't considering here:

  1. Current liabilities - How much money is the company losing each quarter that may cause it to sell repeatedly. If the company is burning through $100 million/quarter that asset is only going to keep the lights on for another 2.5 years so consider what assumptions you make about the company's cash flow here.

  2. The asset itself - Is the price really fixed or could it be flexible? Could the asset seen as being worth $1 billion today be worth much less in another year or two? As an example, suppose the asset was a building and then real estate values drop by 40% in that area. Now, what was worth $1 billion may now be worth only $600 million.

As something of a final note, you don't state where the $100 million went that the company received as if that was burned for operations, now the company's position on the asset is $900 million as it only holds a 90% stake though I'd argue my 2 previous points are really worth noting.

The Following 6 Stocks Are Trading At or Below 0.5 x Book Value–Sep 2013 has a half dozen examples of how this is possible.

If the $100 million was used to pay off debt, then the company doesn't have that cash and thus its assets are reduced by the cash that is gone.

Depending on what the plant is producing the value may or may not stay where it is. If you want an example to consider, how would you price automobile plants these days? If the company experiences a reduction in demand, the plant may have to be sold off at a reduced price for a cynic's view here.

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  • Thanks, the price to book ratio is roughly 0.9, and the 100 million was used to reduce it's leverage. The company isn't making losses. Can I view this positively, and "should" the share be considered undervalued? The asset is something like production plant/factory, so I think the value should stay around the same as it produces x amount of the goods yearly.
    – Nathan
    Jan 12, 2014 at 18:40
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    @Nathan If you say "the 100 million was used to reduce its leverage", then that means the company has/had debt. See my answer.
    – Chris W. Rea
    Jan 12, 2014 at 21:01
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    It doesn't deserve being placed in a separate answer, but keep in mind as well that actually liquidating an asset will frequently diminish its value. For instance, your home may be worth $400,000, but if you go to a realtor and say "I need to sell it tomorrow," you might only sell it for $300,000.
    – Benjamin Chambers
    Jan 12, 2014 at 21:16
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Imagine a poorly run store in the middle of downtown Manhattan. It has been in the family for a 100 years but the current generation is incompetent regarding running a business. The store is worthless because it is losing money, but the land it is sitting on is worth millions.

So yes an asset of the company can be worth more than the entire company.

What one would pay for the rights to the land, vs the entire company are not equal.

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  • Thanks, if the entire company is valued (from the stock market) less than the value of the land that the company owns, can't someone just buy the company at the undervalued price and sell the land to gain a profit?
    – Nathan
    Jan 12, 2014 at 20:24
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    @Nathan Buying an entire company looks easy on paper, but when you actually start trying to buy up all of the shares for a company, the share price quickly gets driven up in the market, perhaps even to a premium. Once you own a certain percentage of the shares, you also have to disclose that fact. Additionally, many companies have provisions to prevent a hostile takeover, such as "poison pills", dual-class or multiple voting shares (putting control in the hands of a minority shareholder or family), etc. It does happen, but it isn't easy enough to say somebody can "just" do it.
    – Chris W. Rea
    Jan 12, 2014 at 20:50
  • This is the closest to the point I wanted to make... the value of the asset licensed at a $1 billion valuation is the value to the entity buying the license. The owning company might not have the capabilities to unlock the $1 billion value an asset represents. An argument can also be made that the licensee probably sees very much more than $1 billion in value from an asset, or they wouldn't have paid the price.
    – THEAO
    Jan 13, 2014 at 16:22

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