In July of 2018, the New Mountain Capital venture capital firm was bracing for the sale of its holding, Western Dental Services, which operates a chain of dental clinics in California, Nevada, Texas, Arizona, and Alabama. In California and Texas, Western Dental and its subordinate affiliates represent the single largest Medicaid dental provider.
New Mountain Capital acquired Western Dental in 2012 from prior portfolio holder Court Square Capital Partners. New Mountain greatly expanded Western Dental’s number of operational clinics, primarily by acquiring smaller dental service organization (DSO) chains.
Western assumed a multi-branding strategy, as many acquisitions retained their former brands. This included South Texas Dental, which operates in Texas, and Vital Smiles in Alabama. Western and its parent company, Premier Dental, also forged a greater emphasis on orthodontic services, largely targeting the Medicaid sector.
In 2018, analysts expected Western Dental to generate north of $100 million in earnings that year before interest, taxes, depreciation, and amortization (EBITDA). The company also was expected to fetch a multiple of EBITDA well into the mid-teens based on valuations commanded by recent DSOs of scale. Plus, analysts believed that large sponsors as well as pension and sovereign wealth funds were flocking to the sector because of attractive insurance dynamics and significant white space for consolidation.
Deutsche Bank and Moelis had been engaged to assist in the sales process. Analysts further noted Western’s benefit from scarcity value, as it was one the few large-scale DSOs operating in the dental market. One might have assumed a sale was imminent.
Fast forward to today, a year and a half later. Western Dental has not been sold. Some things remain the same, others have changed, and our perspectives have gained added clarity.
Dental Marketplace Diversity
It’s a false construct to lump all large-scale DSOs into a common category. They all have different business models, marketing strategies, and target demographics. Also, not all DSOs have a footprint in the dental Medicaid sector. Medicaid fees are set by state governments, which largely impacts a DSO’s bottom line. Further, Medicaid regulation and especially enforcement of that regulation can negatively impact a DSO’s viability.
The largest DSO in the United States is Heartland Dental, which is in the portfolio of publicly traded KKR. Heartland has virtually zero activity in the Medicaid sector. It has a few fresh startup clinics (de novoclinics), as most are not established on speculation, but acquired from individual dental practitioners and smaller group practices.
Heartland’s branding is stealth, as few dental patients realize what is or isn’t a Heartland supported practice. Its target demographic is middle class and upper middle class fee-for-service patients, which represents a stark contrast to Western’s models.
Aspen Dental, another large and dominant DSO, primarily establishes its brand through de novoclinics. Marketing continually references the Aspen Dental title, and all clinics prominently display the Aspen Dental name.
Aspen has little or no presence in the dental Medicaid sector, though it continually advocates for patients’ access to care. Its target demographic is middle class to lower middle class patients, with ads touting discount coupons and free introductory services for non-insurance patients.
Meanwhile, private equity firm L Catterton acquired Dentalcorp in April 2018, with a sale figure approaching close to 14 times its EBITDA.
The Canadian dental marketplace is very different from the United States. There is far less dental insurance intrusion and manipulation of the market. Each province establishes its own suggested fee guide for dental services. Fees in the Royal College of Dental Surgeons (similar to state dental boards) guide are based upon a collection survey for all dental providers within their province. It’s not set to some artificially generated usual, customary, and reasonable (UCR) fee structure, creatively designed as business proprietary data for the insurance industry.
Current Dental Marketplace Realities
One should seriously question if a 14X multiple of EBIDTA can today be achieved across the board from sale of a DSO based in the United States. Lumping all larger DSOs into a common grouping would be ludicrous to prudent investors. Like must be compared to like.
Similar real estate properties in southern California and south Texas may have very different dollar appraisals. Likewise, a DSO operating under one business model versus another operating under an entirely different model should command different valuations.
Interest rates have remained relatively low over the past couple of years. Money is cheap. That’s the common factor. But that won’t always be the case, as we know from the history of economic cycles.
What has changed is that any productivity elevation in EBIDTA may have already been squeezed out of many DSOs. If a DSO is forced into dubious means of production to increase EBIDTA, its valuation, if not its viability, may be negatively impacted. This was a hard lesson for Chicago-based Valor Equity Partners and the bankruptcy of its holding of All Smiles Dental Center Inc.
Interestingly, on November 27, 2019, private equity news journal PE Hub reported that New Mountain Capital was still seeking a buyer for Western Dental, but that report has since been pulled from reader access.
Investors beware. Private equity firms selling their asset DSOs may not be proffering full disclosures. Companies that operate and prosper by misrepresentations and extra-legal means cannot and should not be trusted. The game is to hold a DSO for three to five years and build up EBIDTA to the highest multiple feasible. Then, these firms sell their holding to another private equity firm to squeeze out even more.
Too frequently, production numbers are achieved via highly questionable mechanisms. This may include a business model of Medicaid fraud, consumer fraud, misrepresentation of a discount dental plan as an insurance vehicle, bait-and-switch, high-pressure sales, upselling of needless dental services, unbundling of dental services that should be fully covered under an insurance plan, unlicensed management directing healthcare, and nondisclosures to consumers on third-party financing. In this game of musical chairs, many will be left standing, with nothing to show for their time and efforts.
Don’t be fooled by the spin of prospering by economy of scale. Much of the real money today is generated through unethical if not unlawful activities. When regulators and civil courts fully enforce statutes, we will see a day of reckoning.
Holdings in the DSO industry are only for those well versed in dental industry due diligence. Snake oil salesmen (and saleswomen) abound. Yes, patients can be and are victimized. So can investors. Keep your investor’s head on a swivel.
Dr. Davis practices general dentistry in Santa Fe, NM. He assists as an expert witness in dental fraud and malpractice legal cases. He currently chairs the Santa Fe District Dental Society Peer-Review Committee and serves as a state dental association member to its house of delegates. He extensively writes and lectures on related matters. He may be reached at email@example.com or smilesofsantafe.com.