I want to share with you a summary of conversations I have had in recent months with the leadership at many of the largest invisible dental service organizations (IDSOs) (which I will collectively refer to as DSOs in this article) in the U.S. along with my insights into the dental mergers and acquisitions (M&A) markets.
Valuations remain high -- for now
Kevin Cumbus.
We wrapped up one of our busiest years to date in 2022. There were at least 20 private equity-backed DSOs formed in 2022, and they are buying practices to grow and meet the needs of their investors.
The first quarter is always a fascinating time in the M&A markets: Fresh off the busiest M&A closing season (the fourth quarter of every year), there are never enough sellers to meet buyer demand. Each year this results in bidding wars on deals and premiums paid by buyers through the first four to five months of the year. The first half of 2023 will be fast-paced and result in excellent deals for sellers.
Debt financing is running out
DSOs rely on debt to get deals done. In any given transaction, the cash that a seller receives is from the buyer’s lender (sometimes up to 100%), not the private equity company’s or DSO’s balance sheet.
Lenders limit the amount of debt they provide DSOs based on the amount of earnings before interest, taxes, depreciation, and amortization (EBITDA) in any given acquisition and the total EBITDA inside the DSO (this is called a debt-service coverage ratio). As the cost of debt has risen, lenders’ appetite to fund deals has gone down. Most DSOs will be in great shape to get deals done for the first half of 2023, but there is uncertainty around the year’s second half.
Returns for rolled equity in DSOs vary widely
Several DSOs recapitalized in 2022, and some did not provide dentists who rolled their equity the returns they were expecting. We know from some dentists who did deals in 2019 that when the deals were done and the wires hit, they were only offered their money back on their equity roll -- meaning they got no return on the money that they had invested.
On the other hand, some DSOs have returned 2.5 to three times cash on cash return to their dentists who rolled equity in their DSOs. As we all know, there are no guarantees on the value of the stock (remember Enron?), but don’t take any deal with rolled equity without speaking to an expert who knows the facts around the historical returns. It is critical that you fully understand the value of the shares that you are rolling your proceeds into.
Initial public offerings of DSOs are coming
Most elite groups (think 250+ locations) have talked about taking their businesses public for years. With the markets plummeting in 2022, those dreams were put on hold (the number of IPOs in 2022 were at a six-year low).
Why would they consider going public? Valuations for publicly traded DSOs are likely to trade at 20 to 30 times future earnings compared to private market valuations of 12 to 14 times trailing 12-month earnings for similarly sized assets.
In short, these DSOs can more than double the value of their business with an IPO. If you are considering a sale, it could be a good time to hitch your wagon to some of these groups considering an IPO in the next 24 months. However, not all DSOs are going to make this transition smoothly.
Summary
If you are considering selling your practice or group, you need to act soon. The market is frothy with buyers, and 2023 promises to be another buying frenzy.
There are signs of a cooling market during the second half of the year. This slowdown would be offset by an improving U.S. economy and a decline in interest rates. If we face a slower second half of the year, expect to see DSOs get creative with the deal structure to get deals done as they must grow to meet investor demands.
Kevin Cumbus is the founder and president of Tusk Partners, an M&A advisory firm focused exclusively on large and group practices that want to partner with a dental service organization or private equity group.
The comments and observations expressed herein do not necessarily reflect the opinions of DrBicuspid.com, nor should they be construed as an endorsement or admonishment of any particular idea, vendor, or organization.
