COVID-19 Punishes High-Yield Bonds in the Dental Industry

20 May 2020 Michael W. Davis, DDS
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Some household names in the dental industry, particularly dental service organizations (DSOs), were among the top 200 loans with the largest price declines between March 9 and April 8, 2020, according to Moody’s Analytics.

Commonly known as junk bonds, these collaterized loan obligations not surprisingly have experienced steep price devaluations since the onset of the coronavirus pandemic. The healthcare and pharmaceutical segment represents the third most negatively affected industry analyzed by Moody’s.

Losing Companies

Affordable Care LLC saw the steepest decline among dental companies at –32.00. It operates under Affordable Dentures and Implants and under DDS Dentures & Implant Solutions, which it acquired in March 2019.

 

Zest Dental saw the second steepest decline at –26.00. Operating under the Zest Dental Solutions brand, formerly Zest Dental Anchors, it supplies a vast array of dental materials. While it is probably best known for implant prosthetic locators and attachment systems, it also produces restorative composite resin. It distributes the entire line of Danville Materials products, inclusive of its air-abriasion micro-etcher and Micro Prime dentin desensitizer.

Zest Dental acquired Danville in February 2016 and was merged into the private equity portfolio of BC Partners from Avista Capital Partners in February 2018.

Heartland Dental, which experienced the third and fourth steepest declines at ­–22.94 and –22.25, is the largest DSO in the United States. Its majority owner currently is KKR, which is publicly traded on the New York Stock Exchange. KKR primarily acquired its majority interest in Heartland Dental from the Ontario Teachers’ Pension Fund.

More commonly known as dentalcorp, Dental Corporation of Canada Holdings is Canada’s largest DSO and saw the next steepest decline at –21.88. It is part of the L Catterton private equity portfolio. L Catterton is the world’s largest private equity firm. It also holds interest in ClearChoice, which provides dental implant services, and CareDent, a major DSO in Italy.

With a pair of –21.25-point drops, Western Dental is part of New Mountain Capital’s private equity portfolio. New Mountain Capital has been trying to sell Western Dental for some time. Premier Dental Holdings is Western Dental’s parent management company.

Premier Dental has been on a rapid buying spree in recent years. It merged with 14 California Smile Wide clinics in March 2017. Then in August 2018, it added eight offices formerly with California’s Children’s Dental Group. A month later, it merged another 14 California practices from Kids Dental Care. And then in January 2019, it acquired 63 clinics from Guardian Life Insurance operating in Texas, California, and Alabama.

Impact of Junk Bonds

A relatively small handful of private equity and Wall Street firms controls large segments of the dental industry, but they could not do so without aggressively leveraged instruments, or junk bonds. These debt vehicles have seen significant devaluation since the COVID-19 crisis began.

Some of these subprime bonds are classified “cov-lite,” which means covenant lite. They are riskier for the lender, but offer the potential of greater profits. The borrower will enjoy much friendlier terms. Cov-lite bonds were the brainchild of the private equity industry to facilitate leveraged company buyouts, especially during the 1980s. Too many companies of that decade faced negative balance sheets regardless of favorable loan terms. The bubble burst, and a serious economic recession ensued.

Economists today argue whether or not the amount of leveraged debt in our economy represents a house of cards. Regardless, if businesses are unable to pay on their debt load, even the most lenient of loan terms becomes meaningless.

Unpaid lenders may demand debt-for-equity swaps. Other lenders may have little to no confidence in current company management or even in the industry into which they financed. They may quickly sell their debt and take losses at a steep discount and move onto other investments.

Such investment alternatives include prime grade equities, which today sell at historical discounts compared to earnings. Heavily leveraged businesses could very rapidly collapse or be sold off at devalued prices to those with cash available. Cash is king.

Implications for Dentists

These are uncertain times. There are potential risks as well as opportunities. If you work for a DSO, how stable is the company’s balance sheet? Moreover, how can you access those critical figures? Your future and your employment depend on decisions made by individuals far above your paygrade.

If closures of dental clinics occur in any appreciable numbers, prospects will present. The labor market will be rife with skilled auxiliaries, general dentists, and even specialists. An employer may enjoy a wide option of skilled additional staffing. Terms should be very favorable to employers within specific demographics.

Used dental equipment may swamp the market. High-end purchases such as lasers, CAD/CAM setups, CT scanners, and digital x-ray scanners may be widely available at very reasonable prices. Landlords may have entire dental spaces fully established for dental care, with little to no outlay required for tenant/dentist leasehold improvements.

The winners in this scenario will be those with cash readily on hand, such as well-financed solo or small group private practices or larger DSOs.

A lack of cashflow and an inability to service debt will be a deal crusher. That includes every situation from an individual doctor underwater from student loan debt to a DSO that’s unable to return a profit due to service on debt required for expansion.

On one hand, consolidations are expected in the dental industry. Large dental manufacturers may gobble up smaller firms. Dental companies involved in supply chain distribution may diversify by further acquiring consulting outfits or manufacturers of dental equipment and supplies. Large DSOs with favorable financing may merge smaller DSOs or group practices with theirs.

On the other hand, some giants may fall. Some larger companies may split off into two or three smaller but more profitable companies. Any weak division of a company may simply be sold off as is to essentially divest unused supplies and used equipment—sold off for scrap, in other words.

Conclusion

This is not a great time to be holding massive debt in dentistry, whether you’re a recent dental grad or in private equity management of a DSO. Hard choices seem right around the corner.

But for those with solid cashflow or appreciable cash at the ready, this moment appears to be potentially quite wonderful and unique. Positive opportunities seem at the ready for consolidation and control of markets, large and small. Market growth and enhanced profitability seem near for those positioned to take advantage.

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 This email address is being protected from spambots. You need JavaScript enabled to view it. or smilesofsantafe.com.

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