The cheap-money era that dominated the last few years let DSOs grow by buying up practices. With interest rates now higher and multiples lower, three executives say that playbook is over, and the groups that last will be the ones that create value rather than just acquire it.
Here is what three dental leaders have recently shared with Becker’s about how the shift in capital costs is changing DSO growth:
Mark Greenstein. Chief Growth Officer at Heartland Dental (Effingham, Ill.): So many of these [groups] grew in this 2018 through COVID period, so they’re less than 10 years old, and they grew just because interest rates were low. They didn’t put the energy into thinking about how to actually create value. I think they realized a few years ago when they couldn’t sell, now what are we going to do? So, they started to do the things that Heartland always does, and they’ve created more valuable assets. The quality of what’s out there now is better. Pricing expectations are more in line with the value that’s actually been created. They’ve actually started to create value in several dimensions. There are more doctors that have been there for a longer period of time, so it’s not just churning through doctors. That, to us, is a real signal of stability, how embedded they are with their communities and the overall quality.
Many of these startups from the last decade or eight years have finally recognized they weren’t going to sell. They recognized they had to create value to get the EBITDA to try to get enough of a return to make everybody happy, whether it’s the debtors or the equity holders, and they’re willing to monetize what they have because interest rates now are very high, so it’s very difficult for them to continue to grow the assets. They have to grow by creating value to get the pricing that would work for them, and that’s what we’re out there looking for. We’re looking for that quality at a fair price.
Geith Kallas, DDS. CEO of Smile Maker’s Dental Center (Tysons Corner, Va.): The cost of capital and growth is cyclical, but on a longer cycle. From 2019 to 2021, money was free. There were 4% loans and 15x EBITDA multiples. You could buy a practice, do nothing and make money on arbitrage. From 2023 to 2026, debt is at 9.5% to 11% and multiples at 6x to 8x. De novos cost 40% more to build. Interest rates will come down to 6% to 7% eventually, and multiples will recover. There is still the structural consequence: The era of “buy any practice and grow” is over for now. Only operators who can create EBITDA, not just buy it, will survive. A number of DSOs that grew on cheap debt will go bankrupt in the next 18 months.
Hamza Asumah, MD. Director of Operations for Juniper Services (Sparks, Nev.): We have to understand exactly what the interest rates are now, and what that means for small DSOs, for medium-sized and for larger DSOs. Who is at a good place to be able to really leverage some of these things? That’s going to be very important because when interest rates were close to 0% between 2019 and 2021, people were buying practices at 12x-13x multiples. Now, interest rates are 4% to 4.5%, which is really high, so nobody’s willing to buy practices at that. So, the way those deals are structured is going to definitely change. I don’t see them slowing down, it’s just how they’re structured … The quality of what you acquire is going to be very important. How easy is it for that acquisition to be integrated? That’s where most, especially smaller DSOs have struggled. You acquire the practice, but integrating them into your infrastructure and leveraging that piece is what is going to be important.
