When interest rates were low, dental service organizations could grow by buying practices at lower multiples and selling the platform at a higher one.
That worked until rates began to rise, recapitalizations stalled and the multiple-arbitrage model ran out of road. Same-store growth is now the lever DSOs are looking to, and pulling it requires a level of centralized integration most platforms never bothered to build.
Whether acquisitive DSOs can get there is, as Alex Sharp, DDS, CEO of Scottsdale, Ariz.-based Shared Practices Group puts it, “the billion-dollar question.”
Creating a full-fledged platform vs. a collection of practices
Dr. Sharp said the DSO market is splitting into “haves and have-nots.” The haves have built real platforms that improve each location from the center. The have-nots have assembled “an aggregation of practice assets” and are trying to write a separate plan for every office.
“Something that’s centralized from the inside out, rather than taking all of those individual practices and trying to derive solutions that aren’t scalable because all of the assets themselves are so different,” he said.
At Shared Practices Group, centralization meant planning for it from the beginning. That includes the same practice management software and tech stack, the same procedures, the same insurance plans, supplies and lab partners.
“All of these are opportunities to either gain economies of scale or lose them,” Dr. Sharp said.
His test for whether a DSO has done this: Could you move a team member or doctor from one end of the company to the other and have them be productive right away?
“In our case, can you go from Florida to Washington?” he said. “Can you take a team member, put them in a different practice on the other side of the country and have them understand what is going on in that new practice?”
The acquisition conundrum
A network of de novo practices can make that kind of consistency relatively easy, Dr. Sharp said. Whether or not getting there through acquisitions, the model most DSOs depend on, can still be viable is “the billion-dollar question.”
His answer is to be extremely selective. He said DSOs should be setting clear requirements with potential practices and partners up front. Unless a selling doctor agrees to run the practice the DSO’s way, “you’re going to have a lot of problems achieving that level of integration.”
DSOs that tell sellers nothing will change are making that integration harder, he said.
“If you go into the arrangement with the selling doctor, promising that nothing’s going to change, that it’s only going to get better, sunshine and rainbows are going to abound, then you’re not in a very good position to drive the meaningful change necessary,” Dr. Sharp said.
When EBITDA was enough
Dr. Sharp said it didn’t always matter whether sellers were on board. When the main growth lever was buying practices at lower multiples and selling the platform at a higher one, there was little reason to integrate them.
He said many platforms overpaid for practices and overpromised to selling doctors. Now, they are “underwater financially, and they’re underwater in terms of the social capital that’s been lost” with doctors who are often unhappy with the arrangement.
Debt has only compounded things. Because many groups were underwritten when interest rates were low, their debt payments went up when they refinanced. As a consequence, a recap became something they needed rather than something they could choose.
“You want to be in a position where the fundraising process is a nice-to-have, not a must-have,” he said.
Resetting both DSOs’ and dentists’ expectations
For DSOs that built up loosely integrated portfolios, Dr. Sharp suggested stopping to reset with their affiliated doctors through a town hall or one-on-one meetings.
“Here’s what we thought we knew five years ago. Here’s what the market has told us. Here’s what we now know. Here’s what’s necessary for us to circle the wagons and go forward in a more sustainable and scalable way,” he said. “It’s going to require all of us to take our medicine and make these changes.”
He said the reset gives DSOs a firmer base to be “more choosy about the practices that you let in” and to set clearer expectations once those practices join.
“The best time to have planted a tree was 20 years ago. The next best time is today,” Dr. Sharp said. “That change management that’s going to be necessary in a lot of these organizations — you just got to rip the Band-Aid off.”
