Like many sectors of health care, the dental space has suffered through a traumatic period brought on by COVID-19. We reached out to a number of our contacts in the dental space, including operators of different sizes located in geographies across the United States, in an effort to gather real-world, anecdotal evidence of the impact that COVID-19 has had on operations as well as on deal-making activities.
COVID-19 Impact on Operations – Then and Now
Regardless of the size of the operation or the geography, patient volumes declined precipitously with the onset of COVID-19. In many cases, revenue and patient visits dropped by more than 90%. The vast majority of visits during the early months of COVID-19 were for emergency procedures. A large operator we spoke with closed a majority of its offices and utilized call centers to triage emergency situations to those offices that remained open for business. Hygiene visits, and the follow-up treatments that often result from them, flatlined in many parts of the country.
Fast forward to today and it appears that the volume of visits has largely recovered with several respondents indicating near full recovery, even when adjusting for the effect of burning through the backlog of deferred visits.
Of great concern for most of the DSOs we spoke with are (i) the failure of hygiene visits to fully recover as many patients are still unwilling to risk their overall health for this service, and (ii) the potential impact on business recovery of possible COVID-19 spikes this Fall/Winter. PPP loans combined with aggressive expense management and capital support from financial sponsors allowed most DSOs to managed through the crisis thus far. That said, with many smaller dental practices operating with limited cash resources (30-45 days), any further interruptions to operations could be devastating.
On the HR front, several of the operators we spoke with indicated difficulty in attracting hygienists due to fears around possible infections given their relatively higher risk of exposure. However, some also noted that attracting new associate dentists to their practices has become somewhat easier as many younger dentists are becoming increasingly risk averse in this COVID environment and less likely to “go it alone”.
In terms of bright spots of relative strength, certain practices, including orthodontics and pedodontics, and other specialty areas, such as endodontics, seem to have come through this period without quite the same levels of patient visit volatility.
A few large DSOs, which were relatively highly levered before the onset of COVID-19, found their leverage levels unsustainable in light of the dramatic decline in visits. In the case of Benevis, backed by Littlejohn & Co. and Tailwind Capital, the result was a Chapter 11 filing. In other cases, such as with Elite Dental Partners, backed by Cressey & Co. and Tyree & D’Angelo Partners, restructuring debt at the expense of equity holders may be the key to survival.
Like most other sectors, M&A activity in the dental space went on hiatus for a few months with most significant deals in the market hitting the pause button from mid-March through June.
Beginning in June, DSO deal activity began picking up again, and the number of DSO deals closed through the first nine months of 2020 (as reported by Capital IQ) is essentially unchanged from the same period in 2019. Of note, prices being paid in terms of multiples remain relatively strong. For good quality assets with scale, multiples are essentially unchanged. However, one of our respondents did indicate that there has been some pull back in pricing for smaller, single-site assets with prices being paid declining by 10-15% to approximately 70% of revenue.
While we did hear mention of increased use of structure (earnouts, other forms of deferred compensation, etc.), this doesn’t appear to be widespread. Rather, the amount of equity roll for the DSO seller is increasing, particularly in instances where the purchase multiple is being pushed up. Higher multiples typically equate to greater equity roll, and, in some cases can be as much as 40%.
To sum up, we believe that the dental sector will continue to be highly attractive for investors as the overall dynamics remain strong, and we don’t see recent events changing anyone’s long-term views. The strong M&A market that we’ve seen over the past several years will likely continue as the dental industry is still largely comprised of smaller players and so remains ripe for continued consolidation.
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