Potential storm clouds on horizon of DSO industry
Michael W. Davis, DDS
All industries go through four lifecycle phases: introduction, growth, maturity, and decline. This is basic to modern economic theory.1 It holds true for nearly every industry, from automotive manufacturing to restaurants, and potentially to dental service organizations (DSOs).
Over the past two decades, the DSO industry at large has experienced explosive growth. However, during this period there have been notable DSOs that have failed. Allcare Dental Management, which operated multiple clinics in 13 states, filed for Chapter 7 liquidation bankruptcy in 2011.2 Church Street Health Management, also known as Small Smiles Dental, ceased operation not because of profitability problems, but because the Office of Inspector General of the US Department of Health & Human Services stepped in. The office determined the DSO was unable to comply with a mandated corporate integrity agreement for the lawful delivery of dental Medicaid services.3
Developments in financing have also affected DSOs. In late 2016, East West Bank (EWB) disengaged from its dental lending platform for group practices and DSOs.4 More than 100 group practices and DSO borrowers are financed through EWB.4 These types of borrowers will now need to seek alternative means for future financing. Similarly, Opus Bank discontinued its dental lending platform in late 2016.5
Unlike large DSOs that are financed by private equity firms, many small and midsized DSOs are financed by bank loans. Drying up of potential capital for growth and expansion of small and midsized DSOs could impact the industry. Large DSOs - or more specifically, their large private equity owners - could be positioned to acquire and consolidate small DSOs. This could occur with private equity investment funding, meaning discounted acquisition costs. The bottom line: large DSOs could be positioned to out-compete small DSOs and force them to abandon markets.
If cash flow for small DSOs is insufficient to fund expansion, their growth could slow. Because midsized DSOs currently represent the largest growth segment of the DSO industry.4,5 this could result in an overall slowing of the DSO industry.
Because most DSOs are privately held entities, their financial records are rarely disclosed. Thus, it is often difficult to gauge the health of this industry as a whole. One exception is publicly traded Birner Dental Management Services (BDMS, doing business as Perfect Teeth Dental). BDMS must comply with US Security and Exchange Commission rules for disclosure and issuing public records. BDMS’s most recent annual report, released in the fourth quarter of 2016, was noteworthy.6 Production revenues continued on a downward trend, staffing of clinics with doctors and auxiliary personnel was an ongoing problem, and tangible assets were minimal.
Last year, BDMS was delisted from NASDAQ. It is now traded on OTCQX. BDMS is in default to its lender, Guaranty Bank and Trust Company (a Colorado-based bank). Per conditions of the default, BDMS is prohibited to pay shareholder dividends. The bank has imposed strict terms with forbearance of its loan to BDMS. Further, BDMS is the current target of a hostile takeover, which current management blames for much of the company’s fiscal woes.6,7
One can only speculate if the problems of BDMS are shared by other entities within the DSO industry. Again, little is publicly disclosed. One is often left to rely upon whispers from insiders of the DSO industry.
Very recently, midsized DSO Jefferson Dental Care was sold off by Black Canyon Capital to Brentwood Associates, another private equity firm, which has six times the capitalization.8 Jefferson Dental Care operates 53 clinics, down from more than 80 clinics a few years ago. Initial financing for Black Canyon Capital’s acquisition and operation of Jefferson Dental Care in 2014 was through bank lending of BMO Harris Bank.9
The growth phase of the DSO industry may be starting to plateau, perhaps in a transition to a mature phase. As evidence, some DSOs are consolidating operations, such as when Smile Brands (in portfolio of Gryphon Investors) closed its Monarch Dental clinics in New Mexico last year. As some banks become tighter with their lending practices to DSOs, interest rates continue their steady tick upward. Cheap capital may be harder to access, especially via traditional bank lending.
It’s also possible that some DSOs are overvalued, and recent developments are reflecting this. One could even speculate that there is a market bubble. Regardless, there appear to be a few notable storm clouds on the horizon. Industry shakeups are inevitable, and the ride will be bumpier for some more than others. Large private equity firms may be best positioned to weather any storm that strikes the DSO industry.
1. Industry life cycle. Inc.com website. https://www.inc.com/encyclopedia/industry-life-cycle.html. Accessed April 29, 2017.
2. Allcare Dental Management lists $0 assets, $3.6m debt. WIFR News website. http://www.wifr.com/home/headlines/Allcare__134614693.html. Published November 29, 2011. Accessed April 29, 2017.
3. OIG excludes pediatric dental management chain from participation in federal health care programs. Office of Inspector General, US Department of Health & Human Services website. https://oig.hhs.gov/newsroom/news-releases/2014/cshm.asp. Published April 3, 2014. Accessed April 29, 2017.
4. Cumbus K. East West Bank exits the dental lending market. LinkedIn website. https://www.linkedin.com/pulse/east-west-bank-exits-dental-lending-market-kevin-cumbus. Published November 30, 2016. Accessed April 29, 2017.
5. Cumbus K. Another one bites the dust - Opus Bank exits the dental practice lending market. LinkedIn website. https://www.linkedin.com/pulse/another-one-bites-dust-opus-bank-exits-dental-practice-kevin-cumbus. Published December 14, 2016. Accessed April 29, 2017.
6. Birner Dental Management Services, Inc., 2016 annual report. Seeking Alpha website. https://seekingalpha.com/filing/3483644. Published March 31, 2017. Accessed April 29, 2017.
7. Miller B. Perfect Teeth parent and activist shareholders are in a donnybrook. Denver Business Journal website. http://www.bizjournals.com/denver/news/2017/04/05/perfect-teeth-parent-and-activist-shareholders-are.html. Published April 5, 2017. Accessed April 29, 2017.
8. Dorbian I. Black Canyon sells Jefferson Dental Care to Brentwood. PE Hub Network website. https://www.pehub.com/2017/04/3447676/. Published April 10, 2017. Accessed April 29, 2017.
9. BMO Harris Bank agents $47MM facility for JDC Healthcare Management. ABL Advisor website. http://www.abladvisor.com/news/4951/bmo-harris-bank-agents-47mm-facility-for-jdc-healthcare-management. Published July 2, 2014. Accessed April 29, 2017.
Michael W. Davis, DDS, operates a private general dental practice in Santa Fe, New Mexico. He also provides expert witness work and consultation for law firms; chairs his district dental association peer review; and writes articles on dental ethics and legal cases affecting the dental industry. He is an advocate for the public and fellow doctor colleagues. Dr. Davis can be reached at MWDavisDDS@Comcast.net.