BEWARE THE LARGE CORPORATION OR DSO (PART 1)
Most dentists are unaware that DSO’s in one form or another have been with us for 30 years. Yet, today, DSO has become the buzzword for dentistry’s future with experts predicting that 80% of the dentistry being done in 10 years will be from DSO’s. Currently DSO’s own or control about 17% of practices in the US and are growing about 15% annually while solo practices are shrinking by 7% per year. Historically, 25 years ago, more than 90% of dentists were owners. 76% of dental graduates now go to work for DMO/DSO group practice yearly and this number is also climbing. Like most things, when we look at a large Corporation or a DSO on paper, they have some great possibilities. The problems poke their ugly heads up in the application and reality when we pull back the curtains on their spreadsheets. Can a large corporation or DSO be successful? Some will, but the majority will not. My prediction is that within 5 years we will see the tide turn when private equity firms take their money elsewhere with the realization that this great investment fueled by the herd mentality investing is not creating the returns they had hoped for. If it’s too good to be true, it really is too good to be true.
Before we try to untangle the myths, methods, and future of DSO’s, allow me to quote an article from Bloomberg from June 28, 2018 written by Will Mathis entitled, Private Equity Is Pouring Money into a Dental Empire. I think most of us know that the largest DSO in the US is Heartland, founded by Richard Workman in 1996. Most of the dentists I have spoken to consider this as a very successful organization. With this thought in mind here is an excerpt from the Bloomberg article.
Workman’s empire building caught the eye of KKR & Co. In April 2018, the private equity powerhouse bought a 58 percent stake that valued Heartland at a rich $2.8 billion, the latest in a series for acquisitions in the industry. Other Wall Street investment firms—Leonard Green & Partners to Ares Management—are also drilling into dentistry to see if they can create their own mega chains.”
“It feels a bit like the gold rush,” said Stephen Thorne, chief executive officer of Pacific Dental Services. “Some of these private equity companies think the business is easier than it really is.”
The nitrous oxide fueling the frenzy is credit. Heartland was already a junk-rated company, with debt of 7.4 times earnings before interest, taxes, depreciation and amortization as of last July. KKR’s takeover pushed that to about 7.9, according to Moody’s Investors Service, which considered the company’s leverage levels “very high.” Investors were so hungry that they accepted lenient terms in providing $1 billion of the leveraged loans that back the deal, making investing in the debt even riskier.
“Look at what happened to pharmacy and it’s going to go that way in dentistry,” Workman said. “We (Heartland) can be where Walgreens is in 20 years.”
I don’t know about you, but I don’t want to be where pharmacy, medicine, vision or any other failed healthcare model is today. None of this sounds good to me, yet not only are we headed that way, we are seeing exponential acceleration. I think Workman’s prediction is off and this could happen in 10 years or less.
What has driven this is “fiat money”. Fiat money is currency (in this case it is in the form of credit or digital money) that a government has declared to be legal tender, but is not backed by a physical commodity. The value of fiat money is derived from the relationship between supply and demand rather than the value of the material from which the money is made (or what you spend it on). Now stay with me a little longer. Credit, and the hunger for more and better returns, has fueled this interest in dentistry. The DSO’s of the world are just a vehicle to effectively allow a non-dentist to effectively own a dental practice. In medicine you see this in “for profit” hospitals and large corporate medical groups. What has added fuel to the frenzy is the herd mentality of investors and money managers. The scary part is that the “average dentist” and recent graduates are a major reason for the acceleration. DSO’s and large, private multi-office corporations prey on the weaknesses of the average dentist who has never taken the time to master the “business” of dentistry. For the recent graduate with huge school debt, these organizations offer a job and immediate income. These same dentists are caught in the headlights of this rapid growth while thinking that these massive business organizations will finally allow them to practice dentistry without having to deal with patients, staff, and business. That, my friend, is what the business world calls an employee. These dentists are jumping at a chance to trade their control and ownership to work for taskmasters interested only in profit. Keep in mind that profit in a DSO or corporation goes to the stockholders, not the employees. As an employee, you expose yourself to being fired if you can’t or won’t perform to the level they require in order to generate profit.
A great book about behavioral finance and crowd psychology, Extraordinary Popular Delusions and the Madness of Crowds, written by Charles Mackay in 1841, is a must read for any investor, or in this case dentist, looking to understand the irrational dynamics of markets (DSO’s). This book is a series of historical case studies on crazy things that people did. Extraordinary Popular Delusions and the Madness of Crowds does a great job showing how the average person can easily get swept up into the mania or frenzy based solely on a popular delusion. In dentistry we need better systems, protocols, engagement in the business of dentistry, help with HR, accounting, and financial strategies. We should be able to have more than 4-6% of our retiring doctors be financially set for life at retirement, yet 95% are not. Instead, the DSO offers to partner with you to take care of all those things you never liked to do. The appeal of having this magical third party is based on our own shortcomings – things that each and every dentist should have taken the time to learn. Or failing that, at least hired staff to compensate for those areas we fall short in. Consider this: You are turning over all of the control of your business with the exception of clinical decisions to a third party in the form of a management service agreement with some promise of adding your practice together with dozens of other practices and then brokering their sales to some yet unknown third party at 10 times EBITDA. Great offer, because it plays to the greed of our lizard dental brains, without having any substance of historical truth to back the story book finish we all dream of. Keep in mind that once you sign up with a DSO you will find it incredibly difficult to untie that knot. The real fact is that for pennies on the dollar, you could go hire a consultant, a CPA, a marketing advisor, etc., better than any DSO could supply you with and maintain complete control as your profits soar. The error for most DSO’s is leaving out one very important fact. Because the dentist most attracted to a DSO strategy just wants to do the dentistry and not have to really deal with those crazy staff members and all that business stuff is the very reason the practice doesn’t do well. The DSO buys the practice and still keeps the number one reason this practice struggled all along: The owner dentist. I think most of us would agree that this is a pretty significant flaw in their strategy. That’s like thinking a half ass work out goal will trump a horrible diet. If Heartland is any indication of the future of dentistry, perhaps our future needs to be reevaluated.
Right off the headlines of today:
• Dental chain to pay $1.4M to resolve Medicaid billing case.
• Texas chain to pay $8.45M to settle Medicaid fraud case.
• Iowa dental chain settles Medicaid fraud claims.
• Small Smiles agrees to $39M settlement in mistreatment lawsuit.
• Smile Magic dental clinics agree to $4.5M settlement in Texas Medicaid fraud case.
• DSO’s ImmediaDent and Samson Dental Partners have agreed to pay $5.1M in fraud allegations.
• Benevis and more than 130 Kool Smiles clinics agreed to a $23.9M settlement for submitting false claims.
• Aspen Dental settles civil penalties pressuring dentist to increase revenues by using high-pressure sales techniques.
• TV show (Dr. Oz) covers dental scams and complaints about DSO’s.
You get the idea. What is really driving this negative press about DSO’s, which will also affect everyone reading this, is that as large corporations grow by mergers and acquisitions they are finding that they struggle to actually deliver on individual growth and profitability in each of their practices. Some then turn to unsavory actions and strategies that often go outside their legal ability as well as skirt the standard of care for patients while crossing the line to influence clinical decisions that violates the dental practice act in almost every state. If these DSO’s continue to operate as if dentistry is a commodity instead of a business based on relationships and service, we will find ourselves doing nothing but working for a taskmaster to only sell products and services. What is making this possible today that wasn’t there 15 years ago is an ever-increasing graduation rate from dental schools, additional schools (11 in the last decade and more on the way), and fewer and fewer graduates seeking ownership. With almost a 50/50 split of male to female graduates and generational challenges, this is a trend that is also escalating. Only 32% of females are going into ownership and only 67% of males. That means about 50% of graduates today will never own a practice. This insures an unlimited number of dentists to feed the expansion of DSO’s. The ripple effect is that with fewer owners there will be fewer buyers for practices in the future, which will drive down the values for selling doctors. Yep, it is starting to look like the independent practice of dentistry is circling the drain.
Stay tuned for Part 2 next Thursday.
Michael Abernathy, DDS