Last week my partner,Kevin Cumbus, and I braved the cold of Chicago to do some networking and educate ourselves at the McGuireWoods Healthcare PE Conference. The action is fast, and education comes courtesy of a firehose.
Here are the three main things we learned.
Key Healthcare Business and Market Trends & Opportunities:
Everyone wants to know if we’re “at the top of the overall healthcare market” as it relates to valuations. The short answer is that nobody really knows, but the good thing is that in our world valuations are driven by earnings – not eyeballs. 2017 was phenomenal and the M&A sell side has been robust for 18-24months. Equity markets have been strong and debt markets have been very favorable. The great lending environment has been great for buyers using both debt and equity.
Strategic buyers are still flush with cash and need to show growth for good stock prices, so there’s still a strong drive to expand their businesses. Financial sponsors have been successful at raising funds, but they’re under some pressure to “use it or lose it,” so there’s lots of cash on the sidelines. All of this is great for sellers. 2018 started with a brief headwind with debt market pricing going up, but tax policy is fueling the economy and all indicators are that 2018 will be strong.
As buyers stare down high multiples, they will start to take a harder look at the management team leading the company to be acquired. Are the businesses being acquired sound operationally? Or are they just the beneficiary of strong tailwinds (like demographic shifts, payor changes, etc.)? Lew Little, CEO, Covenant Surgical Partners, had a great quote:
“Focus on people. Mediocre leaders can make a great business average and excellent leaders can make an average business great.”
Words to live by for any growing group dental practice.
There will be more scrutiny and discipline in the coming years as buyers make investments. If a buyer thinks they are buying a platform, they don’t have to be that smart when they’re buying at 3-4X; however, they’d better be able to justify the valuation they paid at higher multiples - and they’d better know how to integrate the acquired asset after they buy it.
One final point on valuations that bears repeating is on adjustments to EBITDA. As the buy-side looks for constant validation of the premium to be paid for established businesses, count on seeing more challenges to adjustments to EBITDA during the negotiation phase. This stands to reason as they are the side that will actually bear the responsibility of the outcome holding up to the projections they presented to their funding partners. I think all of us in the dental space will hear the phrase “quality of earnings” (report) much more frequently as part of the due diligence process. In fact, we at TUSK have started encouraging our prospective sellers to have a Q of E performed long before they go to market in an effort to clean up or get out ahead of any financial issues.
Outlook in the DSO Space:
As it relates to valuation in the dental industry specifically, everybody thinks we’re at the peak – possibly to the point of nearing mathematical possibilities. If Private Equity’s desire to be in the dental space has driven a lot of the lofty valuation multiples, then adding debt with rising interest rates is going to be highly problematic in the years to come. Internally some PEGs are reducing their required return rates to their investors.
Another aspect that could influence dental industry multiples is the fact that in recent years a PEG might be willing to pay 10-12X for a platform because they could then pay 3X for singles. Now there are fewer of those quality 3X deals around, so it makes dollar-cost averaging more difficult. We still live in a highly fragmented industry. Multiples may not go higher, but probably won’t recede in the short term either.
There still seems to be some market segments based on locations. $10MM in EBITDA is still the “magic number” for a guaranteed 10X multiple, but some breakdowns based on locations are roughly as follows:
- 1 to 5 locations at 2-4X
- 5 to 20 locations at 5-9X
- 20-30 locations at 10X
One important thing to note as you travel along this growth journey is that a group practice with more than 10 locations really needs to have a management team and infrastructure in place to be more attractive to the market. From a buyer’s perspective, it’s not worth it to pay a high multiple if they have to come right back and make investments in leadership and systems. Your top line growth can hide broken processes, but not forever. In short, a buyer is better off paying a smaller number for a smaller business, then making those investments as the business scales. They’ll get greater valuation appreciation for the investments they make when the business is at a smaller level.
So, where do the problem areas live? Here are several to note for your business:
- Leadership Team
- Consistent Processes and Systems
- Hiring & Training Strategy
- Consistencies Across the Platform
- Doctor Recruitment & Retention
- “Stroke of the Pen Risk” (government reimbursement)
Tips for Sellers – Ensuring a Smooth Sale Process:
In today’s dental economy, it’s better to be a seller than a buyer for the multitude of reasons we’ve outlined. But that doesn’t mean the sell-side process is always smooth. There are many things a seller must consider as they approach the coming years before an actual sale.
One of the most important things to do is “begin with the end in mind” and think about the 2-3 years post-sale. Buyers will want you and your team to stick around (2 to 3 months of retention isn’t enough). This should make you think of the buyer more as a partner than just the other side of the transaction. Private equity groups come with totally different characteristics and demands, such as:
- Previous healthcare experience?
- Role of SR dentist and founding team (doctor-led or professional management)?
- Culture (can be as important as the economics)
- “Provider First” mentality (can have a positive impact)
- Prior track record (for equity roll)?
- Need a lot of operations heavy lifting?
- More of a strategic partner (in terms of involvement)?
As you build your business, you should be thinking about the two potential groups of buyers: financials and strategics. Strategics are established competitors and are motivated to scale because they reach a valuation premium based on size – not just dots on a map. You should think about your business and where you fit for your competitors. We often refer to this as a “tuck in” where synergies are the primary consideration.
In our industry, it’s much more competitive for financial buyers and the story of your sell-side process is more of a story based on growth. You should consider doing an audit of your numbers (Q of E) to validate your numbers before going to market. PEGs love data, so pick your 5 to 10 metrics that indicate how your business improves on a daily, weekly, monthly basis. They want to see how you benchmark and track metrics as “gut feel” isn’t scalable and doesn’t get credit at the deal table.
Regardless of which buyer you’re positioned to attract, business owners all too often focus on month to month performance, whereas they should be focused on driving enterprise value (expanding EBITDA). If your growth has been based on acquisitions, know what you have paid and be able to show how has the business performed post-acquisition in order to cost average down. Demonstration of your execution is critically important, so be able to explain and identify a setback, then show how you normalized it out over time.
If you’d like our help in defining your own exit strategy or to discuss any other topics related to trends in our industry, please feel free to contact me at Perrin@TUSK-Partners.com. TUSK provides industry-leading resources for Group Dental Practices and DSOs. We help our clients START, GROW and SELL their DSO or Group Dental Practice. For more details, download our Overview of Services or visit our website HERE.
TUSK will be a featured presenter at the 1-800 DENTIST DSO Leadership Summit in Los Angeles, CA on March 16th where we will share “Bank Debt & Growth Strategy: the Numbers You Must Know to Grow.” We hope to see you there as well!