Last week, my Partner, Diwakar Sinha, and I spent most of the week at the American Academy of Dental Group Practices (AADGP) Expo ’17 in Las Vegas, NV. The trip was full of reconnecting with old friends and clients and making new connections as well. There was plenty of excitement this year as it was the 45th Annual Session, and Henry Schein sponsored an additional day of presentations and study before the AADGP on Wednesday.
Over the course of the week, we met with close to 20 DSO owners to discuss their historical performance, outlook on 2017, avenues for growth, and challenges they expect in the years to come. Owners of these businesses expressed concerns over access to capital and increased competition in their markets, which is resulting in difficulty finding acquisition targets and new associate dentists.
Additionally, we talked with over 10 investors in the space, including Private Equity (PE) investors, senior debt lenders, and mezzanine capital providers to better understand their appetite to invest in the sector. Their outlook is positive, however, they all believe that as interest rates begin to climb, leverage will go down and it could lead to a compression in valuation multiples in the market.
We spent a great deal of time speaking with the leading attorneys in the space to get their read on the market. Most have seen an abundance of deal flow in 2016 and expect more of the same in 2017. They are seeing the creation of more and more DSOs, and believe that the market has 10-15 years of runway ahead of it.
Finally, we enjoyed getting to see new business intelligence software and solutions providers in the worlds of insurance, Human Resources, and patient education. There is a ton of innovation in this space right now and lots of great minds and businesses all working daily to secure a position in this market.
Below are three of my big takeaways from the trip.
2 Familiar Names Making a Big Play in the DSO Space: Patterson Dental and A-dec
Patterson Dental is a recent entrant to the DSO world through their Special Markets Division, led by Neal McFadden. I am excited to see Patterson press forward with this strategy in a space that has been for so long been dominated by Henry Schein, Benco, and Dental Health Products (DHPI). Patterson made good press in 2016 by winning the supply business of Heartland Dental Care (the largest DSO in the nation – well, really in the known galaxy) and since then, Neal has rounded out his team with some strong talent that will be working hard to give Henry Schein a run for their money. Hal Muller and his team at Henry Schein have quite a head start in this space so it will be interesting to see these two industry giants jockey for position. At the end of the day, increased competition is good for the business owners of the DSOs and, as long as the cost savings are passed along to the consumer, the patients win as well.
It was a pleasant surprise to see A-dec, a brand that is typically linked to high-end, fee-for-service dentistry, on the trade floor. A-dec recently added John Bettencourt to the team from Patterson, and he was proud of the new prototype for the DSO market: a sub-$10,000 chair. The chair, although still a prototype, will only be available to DSOs with at least 60 OPS and should be available to ship in 4-6 months.
A-dec’s entry and Patterson’s increased commitment to the space are yet another sign that the DSO economy is one to be taken seriously.
The Private Equity Perspective
Although the AADGP had a wonderful collection of speakers, my favorite speaker of the week was part of Henry Schein’s Select Education Forum on Wednesday: Andy Marolda, Managing Director from The Beekman Group. In his 90 minutes on stage, he provided a Masters class on Private Equity (PE) and his company’s investment criteria. It was obvious that Andy knows the space well and he and his team do their homework. Andy made 3 things clear to everyone in the room:
- His group is looking to invest in platform businesses that they can grow – not dots on a map. Platform businesses include infrastructure, systems, and an ability to execute on a growth strategy.
- PE should be looked at as a financial and operational partner – not solely as an exit strategy.
- PE Firms do not take their investments lightly and perform an abundance of diligence on every transaction. Once they have invested, they work very closely with their partners to ensure that projections are met and value is created for all parties.
It was good to hear Andy speak candidly on his excitement about the space and how his firm analyzes the risks inherent in each DSO. All too often at conferences like these, there is talk of selling to a PE shop for a nice multiple and cashing out, but very little about the process of diligence and what it is like after a sale. I applaud Andy for his candor and transparency.
DSOs are in Need of Capital
Over the week, Diwakar and I hosted many meetings with owners of DSOs. Although a handful of the DSOs we spoke with have built strong balance sheets and lending relationships for growth, most expressed one common theme: the need for capital to grow. With East West and Opus Bank exiting the group practice lending business in 2016, many DSOs were left with a strategy and no capital to aid in the execution. Acquisitions and de novos have been pushed or abandoned; strategy has shifted; and owners of these DSOs are courting cash. Most of these groups are either too small or not yet interested in bringing private equity into their businesses. Owners who were once focused on building scale and acquiring locations are now forced to continually scout capital. They complained of the time-hungry process and how seeking capital had become a distraction from their core business.
We spent a lot of time with these owners talking through alternative capital structures and options. For some groups that have a strong operating history, the right story, and leverage ratios, we at TUSK are going to be able to help immediately. For others who signed on to egregious pre-payment terms or floating rate notes with low to negative same-store sales growth, it will be harder. There is smart money to be found to bridge the gap between where these companies are and where they would like to be in their business.
Thanks to the AADGP for an amazing conference this year. We look forward to seeing everyone at the conference next year in Vegas. With Dr. Alex Giannini coming in a President of the AADGP this year, the 2018 meeting promises to be a great one!