Dermatology and aesthetics practices took off after the Great Recession, thrived during Covid, and now show no signs of slowing down. What makes dermatology and aesthetics such desirable investments?

In this episode of The Corner Series, McGuireWoods’ Geoff Cockrell chats with Clint Bundy and Stewart Carlin, managing directors of the Bundy Group, a boutique investment bank specializing in the healthcare industry, to discuss specific considerations for investing in dermatology and aesthetics practices.

Listen as Clint and Stewart explain why those practices are high-value investment targets, including the increasing influence of healthcare technology, the difference between being an investment cornerstone versus an add-on acquisition, and how aggressive investors will keep the market for dermatology and aesthetics providers robust.

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This podcast was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this podcast, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information, or opinions expressed during this podcast series are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.

This is The Corner series, a McGuireWoods series exploring business and legal issues prevalent in today's private equity industry. Tune in with McGuireWoods partner, Geoff Cockrell, as he and specialists share real-world insight to help enhance your knowledge.

Thank you for joining another episode of The Corner Series. I'm your host, Geoff Cockrell, partner at McGuireWoods. Here at The Corner Series, we try to bring together thought leaders and deal makers at the intersection of healthcare and private equity. Today we're thrilled to be joined by our friends at the Bundy Group, Clint Bundy and Stewart Carlin. Clint, if you could introduce the Bundy Group and yourselves before we jump into some questions, that would be great.

Sure. Geoff, thanks for having Stuart and I on today, we're excited about this. Just to give you a real quick introduction, our firm is a boutique investment bank that specializes in representing business and practice owners and a business sale or capital raise event. We have a very strong team and we work throughout the country with clients both in the US and in Canada. Healthcare has been a key specialty of ours going back almost to inception of our firm, and we've spent a great deal of time over the past decade in the physician practice management sector, which includes the dermatology and aesthetic space.

Jumping right in in thinking about the dermatology space, what are some of the key characteristics that have made that an attractive investment area?

Yeah, good question. Firstly, we're in the story business, so let me start with kind of our view in the story of that sector. Is really starting right after kind of The Great Recession back in 2013, the financial sponsor community looked their own kind of assessment on attractive markets and realized, well, wow, the dermatology market did quite well even when the rest of the world was falling apart from 2008 to 2010. So really you saw a pick up in investment activity back starting around right after The Great Recession in the dermatology space and which has continued really up until this day, and we project it will continue for the foreseeable future, but there are a lot of drivers behind it. I'll give a couple and then I'll let Stuart chime in with a couple he may have.

But first it's a fragmented market, so there's a lot of room for the ability for financial sponsors to come in and buy a platform and then do what we would call add-on acquisitions within the space. And two, there's a very recurring like revenue field to the industry where a lot of people who they've got to go see that dermatologist on the medical side every six to 12 months, and that's before you get to any elective procedures. Stuart, I'll let you chime in with one or two that you may have on that front.

I'll add a third, and it gets a little bit more down to the by practice, but I think there's a lot of opportunity to add additional services. In dermatology, we see a lot of practices that they might be more medical focused, but there's also cosmetics. There's lab services that can be integrated. There's most procedures that some practices perform, others outsource, and these are all reflective of additional revenue grabs, if you will, for investors as they look to consolidate the space. And I think that's one of the things that helps them tell the story of how can they start off with a platform of five in EBITDA and grow it to 15 in a short period of time.

Clint, you mentioned that there's runway for the foreseeable future. I just want to pressure test that a little bit. When I talk to some investors, there's a discussion as to how much market saturation exists right now from the perspective of a lot of things have been consolidated, there's still fragmentation, but how do you think about where in the life cycle of consolidation dermatology is?

Yeah, this is certainly a very subjective answer, but based very much on our experience in the market, and I'm going to use baseball analogy. I would say in 2013 the game had barely even started. Now I would say we're probably in an inning, I would put it four or maybe five of a nine inning game. So to put some structure around that, a lot of the larger independent platforms, and let's just put a number to that, let's just say five and up in EBITDA, I'd say more than 50% of those have now been acquired and tucked underneath the financial sponsor ownership structure. Doesn't mean that there aren't still some really large independent groups out there in the dermatology space that are still available for acquisition, there are. We've got conversations going with a number, but there just aren't nearly as many as there were say back in 2013.

So what you've seen a lot of the window closing a little bit is on the larger side where there is certainly a great deal of consolidation to still be had, is under that 5 million in EBITDA, adjusted EBITDA structure. And so that's a lot of, let's call it practices, that have anywhere from one to eighty providers in maybe two, one to three or four locations. There's still a number of those that are independent and still very much available to be acquired and tucked under a platform, or to be used in a consortium sale together with several other practices to sell as one collective unit.

You've talked a bit about some of the tailwinds in dermatology, let's talk a little bit about some of the headwinds. As I talk to dermatology practices and MSOs that are connected to them, one of the recurring themes that I hear is labor pressure and labor pressure translating into labor cost and putting headwinds on performance. How do you assess that dynamic in dermatology?

I love talking about the tailwinds, I'm going to let Stewart talk about the headwinds.

Yeah, I would say over the past 12 months, the admission on headwinds has started to pick up throughout the conference circuit, but the labor market creates rising expenses for the practice, inflation certainly helping as well. EBITDA profile is going to change, and so you've got to add that much more revenue in order to get to say the same 15 of adjusted EBITDA benchmarks. So I think that we do see some cooling, if you will, on how aggressive buyers will get in terms of pricing for deals in multiples, but I think that the offset to that that's been proven out over a number of our recent deals is that there's a mad dash, if you will, for those A-plus quality assets. And so even though there's some headwinds in terms of costs and pressures on margins for the practices out there that are really ticking on all cylinders and providing a great either add-on or new platform, I think valuations at least right now, are not showing as much weakness as we might see in some of our other verticals that we cover.

One topic that comes up a lot in provider services generally and certainly in dermatology is how to think about provider alignment from the embedded economics of the structure. Traditionally, provider economics have been pretty purely production-based. The evolution has focused quite a bit on income repair models or EBPC models where the provider's current economics are more geared towards profitability than just individual production. As you're advising practices that are looking to sell, how much discussion is there around the provider alignment economics that you're going to be seeking in the context of a transaction?

Yeah, I'll take first shot on that and Stewart can, as he always knows, can hack clean up on my answer. But I think for us when we are representing a practice in a sale, one of our first objectives to understand is one, what are their goals post-closed, what kind of role do they want to have? And two, how key are they to the practice today as a revenue producer, clinical provider? We usually are always encouraging practice owners in terms of building value. They should always try to not make the practice solely or primarily dependent on them. But that being said, the reality is that there are plenty of dermatology and aesthetics practices that are heavily dependent on the owner of the practice in terms of revenue production. So in terms of alignment of incentives, we would advise if a practice owner is chief revenue producer that they need to be prepared for everything from an employment agreement that could go, in our view, it could go anywhere from two to five years.

Certainly we will ultimately defer to our friends at McGuireWoods on what they see in terms of the market terms, but it could be a longer rather than shorter employment agreement term. And that the traditional structure, as I think you mentioned Geoff, was a percentage of production that they would generate in the future, but in terms of they as the owner doing their own production, but what we're also seeing now, and we've got a deal right now with an LOI in place where there's a two-layer incentive structure for the physician owner who will stay on post-close. One is his percentage of production and the other is they're going to give him an added incentive to keep that overall location profitable, and they'll give him a percentage of those proceeds in the future on top of frankly, a pretty healthy upfront cash component they're going to pay them for the business. So our starting points on advising on incentives, Geoff.

Maybe turning the conversation a little bit. Historically there were kind of pure dermatology businesses and then there's been a significant rise under the broad heading of med spas. The line between those two extremes has gotten blurry. You mentioned dermatology with aesthetics. How do you think of the blending of dermatology aesthetics, med spa functionality, how do you think about that from the perspective of it expanding into other business lines? Thinking about it from the perspective also of whether or not staying in a pure play position is advisable? How do you think about those topics?

I'll start there and then I'll let Stewart provide any comments, but blending is a great choice of words here, Geoff, and it's been really interesting to watch since the pandemic. So it feels like all new changes in the M&A market come as a result of a market dislocation. And so as a result, primarily of what we saw from the pandemic, the aesthetic space, which are, I'm just going to define that as med spas plus cosmetic heavy dermatology plus also cosmetic plastic surgery, we saw the financial sponsor community completely change its tune on those markets where pre-pandemic, we saw financial sponsor relationships say they had no interest in that space coming out of the pandemic and seeing the resiliency frankly that that market held have seen just an explosion of investment into that static space.

There are absolutely dermatology platform groups that are medical derm heavy that are starting to come around to investing in the med spa space. We saw recently Forefront just did a med spa heavy deal. We've constantly got dermatology focused buyers calling us saying, "I think we're now getting interested in the med spa space as long as we have an angle." You are seeing that blending there, but you're also seeing a real pool of buyers developed that are just focused on the aesthetic space. So Stewart, I'll let you chip in with any comments on that market.

Yeah, I think the only thing I'll add is that to my earlier point about dermatology having ancillaries, I think sometimes the lack of definition or the broad stroke reference to med spa, I mean it really is investors looking for additional ancillary revenue streams, whether it be traditional med spa where they're providing minimally invasive procedures, whether it be health and wellness related, rejuvenative weight loss. I mean, there's a lot of different ways that platforms can carry out the broader focus on med spa. And candidly, I think part of that was a product of COVID, just allowing people to focus a little bit more and bring more to the forefront the idea of proactive health wellness total care, and I think we see that in the addition of med spas joining the narrative around cosmetic derm and medical derm.

One area that a lot of investors are looking for is investment opportunities where they can bring technology to bear on either the market or solving a particular problem, or maybe even generating an additional source of revenue. In the dermatology and aesthetics arena, what opportunities for technology exists?

So Clint, if you don't mind, I'll take first pass and let you jump in? But we see a lot of, not just within our derm and aesthetics, but within our broader healthcare IT coverage, a lot of opportunities and some really unique solutions focused on patient and provider solutions, whether that be helping practices run more efficiently, schedule more efficiently, communicate with patients more efficiently, as well as the technology and opportunity applications of AI that can help in terms of driving more patients to practices. And so I think both from a making things run more efficiently and providing a pathway for providers and their patients to connect, share information, those are very front and center and I think you see a lot of good underlying market fundamentals across that broader digital care management segment.

But then you also have the telehealth angles as you get outside of more procedural base and perhaps on the health and wellness side. And then of course risk management's key in any and every vertical around cybersecurity and how you're integrating a lot of these new systems to make quality of care better, you have to make sure through that information sharing everything is protected. So Clint, I don't know if you want to add anything else to that?

I agree with everything you said, Stewart.

Given the size of the groups that you mentioned you're often working with, let's call it north of five, but less than 10 in EBITDA, that's right around the range where a group could either be an add-on to a larger platform or could be the platform. When you're advising folks that are at that range of size, what are some of the pluses and minuses that they should be thinking about of one path versus the other?

Yeah, and one thing, Geoff, I'll just say is that yes, we love working with practices in that, let's call it five to 10 million in adjusted EBITDA range, or for some practice owners it's easier to understand revenue, which if you want to call it 10 and up in revenue. But we're also, just to give you an example, we're working with a practice in Florida right now, let's just call it a little under 2 million in EBITDA, and it's a great client, great practice and a great location, and I think we've gotten close to double digits in terms of number of LOIs submitted on the deal. So as a boutique we can flex up or flex down.

But to answer your question, the fundamentals that we would advise the practice owners to think about in that range is first, what are their objectives as they are thinking about an exit or bring on a partner to help them grow? The other thing we always like to implore the practice owners to think about is that while they're getting calls from buyers left and right, which is very standard today in the dermatology space, they need to understand that the best way to find the best fit for themselves as well as the best value, is to run some kind of competitive process. So we're big believers and run a structured competitive process and that helps you figure out what's the best fit in alignment. Stewart, I'll let you chip in with anything I may have missed there.

Yeah, I think just getting a little bit more into the nitty-gritty about reflecting and looking at an individual practice as you're thinking about a process, we always start with, we refer to as the four legs of the stool. From a financial standpoint, stability. Has it been stable? Earning stable margins? If not, why? Profitability. I think a lot of the upper tier of deals that we see are showing adjusted EBITDA margins that are 15% and up. Growth. How has the practice historically grown and what are avenues for future growth outside of whether it be adding more providers, more locations, ancillaries, med spas, you name it? And then looking at the scale of the practice just in terms of overall size of revenue and EBITDA. Those are usually our starting points and then we can dip down much more detailed from there in terms of other nuances that help separate practices when we position them in a competitive process.

What are some of the characteristics are you looking for if you're talking to a group that envisions themselves as being the platform as opposed to being acquired by someone? To what extent are you looking and helping them assess in their own characteristics, whether or not they have a CEO that could do that, whether or not they've implemented platform style mechanisms of centralized command and control? A more robust accounting and regulatory compliance program. How much do look at some of those characteristics before allowing a client to conclude that they could be a platform?

Those are all very critical topics for us in assessing a platform versus an add-on. At Bundy Group, a lot of times we'll get involved in conversations with a potential client months and sometimes years before they're actually ready or we actually do take them for a process. And you hit on some of the high points there, it's how much of an executive team is there in additional to the clinical team. Not every position has to be filled out to be positioned as a platform, but to know that you're getting some of those pieces in place to have a system and best practices established, and at least a few core team members, a CEO, a COO, and at least a competent accounting manager or controller, we can certainly position around those elements for a platform.

And then you dig down deeper and you look at what are the number of providers? What are the number of locations? Revenue contribution by location, productivity by provider, how much of a dispersion is there, or is there a large amount of concentration in particular providers? And then I've touched on the ancillary piece a number of times, but what other key revenue drivers exist outside of either medical or cosmetic procedures, and how is the team and that leadership team really thinking about the future from a three to five year plan? I think those are all critical topics. Again, we'll do a lot of work in preparation in helping fully write that script or tell that story, but it's important that some of those pieces are in place and have been in place so that as you marry the historical data up with that story, buyers are able to validate that the components you're putting into in place are working, that you are able to manage that margin profile consistently, and you have some real articulated opportunities for growth, and ideally a demonstrated track record of implementing some of those in order to help scale the platform.

Last question here before we wrap. The market for M&A and provider services has been fairly choppy for the last, let's call it 12 months or so. I always feel that bankers have a little bit better headlights looking down the road as to what to expect just because you're a little upstream of activity. What's your prognosis for the next six to 12 months compared to the last six to 12 months from where you sit?

Yeah, I'll take first shot at that. I'm going to divide this out in the dermatology and then the aesthetic side, just to kind of bifurcate. First dermatology, we've got several clients in the market. We should have a new closed deal announced here in the next hopefully month, in change, which we're in market on last year, and what was a "tough M&A market", and we had great reception on that opportunity. Back to use the term Stuart mentioned earlier, it was what we would use the term an A-plus asset, it was very good practice. And from the clients that we're going to go to market with here in 2024, that range from anywhere from an add-on size to a platform size, their financials are looking good, their momentum is looking good. And from the buyer conversations we're already having before officially heading into market, we think we're getting a great response on the dermatology side. So I do think there's been a normalization to a degree from the buyer community in terms of relative to what we saw last year, and I think buyers are appearing to be more aggressive on the dermatology side, even more so than what we saw in 23.

On the aesthetic side, we see a tremendous amount of momentum within that space, and it's kind of a market grab right now because it's so fragmented in the formation of so many sponsor platforms is still beginning, so we don't really know where that's going to land. In terms of the number of financial sponsor back platforms, there's over 40 in the derm space. Right now, I'd say there's probably about half that in the aesthetic space, but by the end of this year, it wouldn't surprise me if we don't have 40 or more in the aesthetic side, pure med spa side. So lots of interest on the aesthetic side for both add-on's as well as platforms. Stewart, certainly chip in where I may have missed anything there.

Yeah. The only thing I'll add is in this market as a whole, preparation is key. The number of conversations we have with practices where we dig in a bit, we look at the fundamentals and we say, "Hey, you're almost ready, but you're missing this piece, this piece and this piece. Go focus on that over the next six to 12 months, and then we'll be at a more optimal position of strength." We still have a lot of those conversations, and even though buyers are in a little bit of a frenzy around getting into the broader aesthetic space and continue to show a lot of interest on the more traditional derm side, they are still being very selective. They still want those, kind of B-plus or better assets, and so preparation is key in this market, making sure that you understand the pros and cons to your practice from an investment standpoint. Have those conversations early, have those conversations often, and get involved with your advisory team well in advance, because some of the things that you can do in preparation can make a massive difference today. One, just in terms of overall response, but two certainly value as well.

Well, thank you both for joining. A super interesting discussion in an area where there's obviously been a lot of interest, and by all accounts, there's going to continue to be. But thanks again, Clint Stewart for joining me.

Thanks, Jeff.

Thank you, Jeff.

Thank you for joining us on this installment of The Corner Series. To learn more about today's discussion, please email host, Geoff Cockrell at gcockrell@maguirewoods.com. We look forward to hearing from you.

This series was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this series, you acknowledge that McGuireWoods makes no warranty, guarantee or representation as to the accuracy or sufficiency of the information featured in this installment.

The views, information, or opinions expressed are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This series should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.