Valuation Guide: Dental Practices

Industry Description

The dental industry is generally defined as the professional and licensed practice of preventing, diagnosing and treating diseases, injuries, and malformations of the teeth, jaw, and mouth.  The dental industry is highly fragmented, consisting mostly of sole practitioners that practice general dentistry.  Typical dental offices have one dentist, two oral hygienists and one office staff position.  Specialty dental practices include orthodontics, oral surgery, periodontics, and pediatric dentistry.  This industry falls into SIC code 8021 (“Offices and Clinics of Dentists”) and NAICS code of 621210 (“DDSs’ Offices”).  As of 2012, there are approximately 170,000 dental offices in the United States.  The industry generates over $100 billion from dental services annually, an average of between $600,000 and $700,000 per practice.[1]

Demographics drive patient growth rates for the dental industry.  As one might expect, the number of new patients within the industry grows consistent with population increases.  An aging population and innovations in dental cosmetics have combined for strong sales growth.  Despite its long existence, the dental industry in recent years has experienced strong growth fueled in part by cosmetic dental procedures such as teeth whitening and veneers.  Not long ago, elective cosmetic dental procedures accounted for only a small percentage of dental practice revenue.  Now they account for a substantial portion of revenues for many dental practices.  While growth in the total number of dental patients is consistent with population growth, the aging baby boomer demographic has lead to increases in the number of expensive restorative procedures performed.

Not surprisingly, the dental industry has been generally resilient despite prolonged economic sluggishness in the U.S., although the industry has shown weakness more recently.  Like general medical health and education, dental health receives preference in most household budgets.  The high priority given to dental care generally renders the industry largely immune to economic dips.  Of course, like all business, the industry suffers from recessions that are deep enough or long enough.  Unemployed and/or uninsured people may put off dental visits or just “deal with” dental problems.  Forbes reported that while sales growth was robust in 2008 and 2009 (5% and 15% growth) when the rest of the economy was in recession, it dropped to only 1% growth in 2010.

The rise in cosmetic procedures as a percentage of industry revenues represents a two-edged sword for the dental industry.  While cosmetic innovation opens new demand for dental services, such highly optional services can easily be postponed or passed over altogether.  As such, business revenues derived from these sources, like other luxury goods, are more exposed to recessionary pressures.  The traditionally stable revenue patterns common to dental practices could become increasingly volatile.

The dental industry experiences some seasonality.  A publicly traded dental practice, Birner Dental Management Services, Inc., (“BDMS”) observed from its own sales patterns:

“The Company’s past financial results have fluctuated somewhat due to seasonal variations in the dental service industry, with revenue typically lower in the fourth calendar quarter.  The Company expects this seasonal fluctuation to continue in the future.”[2]

Because of seasonal jumps and dips, valuations of dental practices should consider long term sales and profitability, preferably three years or more.

Industry Trends

According to the Center for Medicare and Medicaid Services (“CMS”), dental expenditures in the U.S. increased from $38.9 billion in 1993 to an estimated $102.2 billion in 2009, a cumulative annual growth rate of 5.8%.  CMS also projects that dental expenditures will reach approximately $167.9 billion by 2020, representing an increase of approximately 64.3% over 2009 dental expenditures.[3] BDMS believes industry growth has been driven by (i) an increase in the number of people covered by third-party payment arrangements and the resulting increase in their utilization of dental services, (ii) an increasing awareness of the benefits of dental treatments, (iii) the retention of teeth into later stages of life, (iv) the general aging of the population, as older patients require more extensive dental services, and (v) a growing awareness of and demand for preventative and cosmetic dental services.  Other trends in the dental industry include:

1. More and more dental patients are moving toward third party payment arrangements for dental services as employers increase benefits packages to include dental insurance.  BDMS identifies this as a contributing factor toward “increased consolidation of practices in the dental services industry and to the formation of dental practice management companies.”[4] The Center for Disease Control reports that around 75% of people under age 65 currently have dental insurance.  The move to third party payer arrangements may also explain notable growth in dental expenditures generally.
2. Increased technology and digitization has led to better and faster communication between dental clinicians, teams and laboratories, along with more precise and effective treatment. Technology has broken down the barriers of distance between clinics and laboratories, making nearly instantaneous electronic communication possible both with files and even live video. Along with electronic communication, devices such as digital impression scanners are making it easier to create more precise models electronically, which can be easily sent to laboratories to be processed.[5]
3. Downward pricing trends for insurance are expected to continue with more purchasers looking to lower healthcare costs.  Insurance companies compete on price, and “they have found that the most expeditious ways to lower premiums and compete are to discourage patient utilization, shift costs more towards the patient, or lower fees and dentist reimbursement.” [5] This trend has created heightened cost awareness for both the dental care provider and the patients, leading to a push for more cost effective procedures and products.

Summary of Valuation Approaches

There are four different types of valuation methods that can be used to value dental practices, as follows:

1. Asset-based valuation: This method calculates business’s equity value as the fair market value of a company’s assets less the fair market value of its liabilities.  This approach is also sometimes referred to as a “cost based approach”; that is, the business value is equal to the cost of acquiring its physical assets. This approach is seldom relied upon for a dental practice (unless it is in liquidation) because the value of a dental practice is more closely based on its patient volume than its physical assets.
2. Income approach to value (capitalization of earnings): This method is most applicable to dental practices that face predictable and constant growth in earnings and have a long history of operations. The business value under this method is equal to the cash flow projection for one year divided by a capitalization rate (i.e. the appropriate discount rate less the predicted growth rate).
3. Income approach to value (discounted cash flow): The value of equity under this method is equal to the present value of free cash flows available to equity holders over the life of the business.  This method works well for both established dental practices with low growth rates as well as new dental practices with higher rates of growth, but requires predicting changes in future cash flows.
4. Market approach to value: This method utilizes market indications of value such as publicly traded comparable company stock and acquisitions of privately held dental practices.  The financial metrics of public companies or those of private transactions can be used to create valuation multiples that are then used to calculate business value.

Financial Benchmark Statistics

The following financial statistics are based on a study of approximately 800 dental practices in the U.S.[6]

	2007	2008	2009	2010	2011
Operating Profit (% of Net Sales)	12.6	13.0	12.9	14.6	13.8
% Owners Compensation/Sales	19.1	18.1	17.7	16.6	16.7
Sales/Fixed Assets	12.4	12.1	13.1	13.2	14.0
Current Ratio	0.7	0.7	0.8	1.0	1.0

 

These metrics show that over the past five years, operating profits as a percentage of net sales have remained steady although owner’s compensation as a percentage of sales has steadily declined.  Meanwhile current ratios (current assets to current liabilities) have steadily increased since 2007.

Industry Organizations and Publications

Information on the dental industry may be obtained from various industry associations.  Some of these include:

1. American Dental Association, ada.org, consists of 157,000 members, founded in 1859 and claims to be “the oldest and largest national dental society in the world.”
2. Dental Economics, dentaleconomics.com, a subscription magazine that follows industry trends that involve running a dental practice.
3. Academy of General Dentistry, agd.org, publishes bi-monthly journal General Dentistry, “presents research and clinical findings to support the full range of procedures that general dentists perform on a regular basis.”
4. Dental Products Report, dentalproductsreport.com, a magazine with a primary focus on products used in dentistry.
   

Availability of Publicly Traded Comparable Companies

While there are several publicly traded companies that are in the dental industry, Birner Dental Management Services Inc. (NASDAQ: BDMS) is the only publicly traded dental practice company in the U.S.  The company owns the trademark “Perfect Teeth” and has affiliated dental practices in Colorado, New Mexico, and Arizona that operate under this trademark.  Its affiliate practices offer general dentistry as well as specialties, including orthodontics, pediatrics, oral surgery, and endodontics.

Around the time of this report, BDMS had a price to earnings multiple of 24.1 and a market cap of $31.1 million.  The company’s beta (a measure of how the stock price moves relative to the rest of the market) is 0.72, indicating lower-than-average volatility.  The stock is lightly traded and has fewer than 2 million shares outstanding.  Only 3% of the company is under institutional ownership while 65% is held by insiders or owners who control at least 5% of the company.  The appropriateness of using these measures when valuing a dental practice requires careful assessment of the subject practice and additional scrutiny of BDMS.

Non-U.S. publicly traded dental practice companies include 1300 Smiles Limited (ASX: ONT), Topchoice Medical Corporation (SHA: 600763), and Abano Healthcare Group Limited (NZE: ABA). Absent further analysis or case-by-case necessities, non-U.S. companies may not be appropriate for valuing a U.S. based dental practice.  This is because industry conditions can vary significantly across countries.

Private Transaction Data

Since there is only one publicly traded dental practice in the U.S., an appraiser may need to rely more heavily on data from private transactions. One database that tracks private transactions records 85 transactions involving dental practices in the U.S. since September 2007.[7]  These dental practices range from $221,251 to $6,933,800 in annual sales.  The following multiples are calculated from these 85 transactions:

1. Market value of invested capital to Net Sales (MVIC/Sales) valuation multiples ranged from 0.37 to 0.97 (median of 0.61),
2. MVIC to earnings before interest, taxes and depreciation (MVIC/EBITDA) valuation multiples had a median of 16.7.  This valuation multiple in particular is probably not informative since dentists have the discretion to take profits as salary or as a dividend distribution.  A review of transaction data indicates that a substantial portion of dental practices appear to take profits as salary.
3. MVIC to discretionary earnings (a measure to address the problem raised with MVIC to EBITDA) has a range of 0.52 to 2.89 and a median of 1.2.

The wide ranges in these market multiples render them of limited use without further analysis.  These wide ranges are likely attributable to various factors.  Some of the factors that may affect these valuation multiples or could affect the subject company valuation include:

1. Date of transaction/valuation and prevalent industry conditions at the time
2. Duration of the office lease and landlord/tenant relations
3. Proximity of the facility to highly populated areas
4. Median household incomes for neighborhoods within close proximity of the facility
5. Value of physical assets (i.e. condition of dental equipment)
6. Practice’s financial performance history
7. Competitive environment of the local area (concentration of dental practices)
8. Established clientele and patient demographics

Fulcrum Inquiry performs business appraisals for dental practices and businesses in other industries.