All sectors of the healthcare market are experiencing investments and growth. Dental and specialty dental practices are part of this growing trend. 

In this episode of The Corner Series, McGuireWoods’ partner, Geoff Cockrell speaks with Karan Garg, who is a Partner and serves as Head of Healthcare Services at Solomon Partners, a leading financial advisory firm and one of the oldest independent investment banks. Geoff and Karan discuss the provider services industry, with a specific focus on the dental market and related specialty niches. 

Tune in to hear Karan share his experience and insights in the dental arena, including growth strategies, risks and headwinds for dental platforms, market trends, and his 2024 prognosis for provider services and dental services in particular.

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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 McGuire Woods series exploring business and legal issues prevalent in today's private equity industry. Tune in with McGuire Woods' 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 McGuire Woods. Here, at the Corner Series, we bring together thought leaders and deal makers at the intersection of healthcare private equity investing. Thrilled to be joined by my longtime good friend Karan Garg at Solomon Partners. KG has been just a force of nature in provider services investment banking, especially in the dental arena. I think he's probably done more dental related deals than anybody I know, but we're going to spend some time talking about the dental market right now, and maybe some of the other provider services niches. But KG, maybe give a little introduction and tell us a little bit about Solomon Partners.

Absolutely, Geoff, thank you so much for having me on the podcast. Really appreciate the opportunity. So, as Geoff mentioned, I've spent the last 20 years, my entire career in healthcare services, specifically focused more on the provider side of the sectors, and more specifically around in dental and other physician practice management areas. I spent the last 15 plus years at Houlihan Lokey in their healthcare M and A group, based in Chicago, leading efforts in the healthcare services arena, and then recently moved to Solomon Partners, two months ago, as a partner leading the healthcare services effort for the firm. For those of you who don't know Solomon, Solomon is a boutique investment bank headquartered out of New York. We've been around for 35 plus years, with offices in New York, Chicago and Miami, 200 plus bankers covering 15 plus sectors, and all we do all day long is provide independent trusted advice to corporations, private equity clients, entrepreneurs and founders.

So, KG, maybe starting with dental consolidation, we've been talking about dental consolidation for a decade. It's obviously a big industry, but is there going to come a point where they're run out of things to consolidate?

I get this question asked quite a bit, so just to put things into perspective, this is $150 billion plus market on an annual basis, and with nobody today, at least no one company that covers or accounts for more than a couple of percentage points off that entire market, which is quite unusual, which basically tends to lean into talking more about the fact that there's a highly fragmented marketplace, and it's continuing to consolidate. Even today, depending on how you look at it, in terms of number of actual providers, or in terms of revenue, or in terms of number of offices, the overall consolidation is somewhere in the mid 20% range and feels that there's still a lot of runway to go from here, in terms of continuing to consolidate.

What I have seen what has changed over the last five years or so, and a lot of that is a function of how new graduates, new dentists, new providers coming into space and what their demands and expectations and how they are thinking about their particular careers, has shaped the way the consolidation is happening. We've seen a birth of what we now call specialty dental platforms, so there are orthodontic specific platforms, there are oral surgery specific platforms, there are endodontic specific platforms, which didn't exist previously, all of this was mostly a multi-specialty consolidation, where you had endodontists in a particular office and it was just part of the overall consolidation pool. But, given the demand from the talent pool itself, it is driven and given birth to these new specialty models, which make the delivery of care even more efficient for the patients, and is more streamlined from a provider perspective, as well.

When you think about a general dentistry, smaller shop, there are things that they probably can't do that something of scale could do. How would you articulate the benefits of being bigger in the delivery of dental services?

Especially in this environment, where there's obviously wage inflation, there is labor shortages, typically what I see is if you have a scaled enterprise and have market density, you are able to serve the patient better, and typically see in smaller institutions or smaller organizations, which don't have density of scale in a given market, they tend to lose market share because they're not able to take care of the patient right there and then.

The consumer demand or the patient demand has also shifted quite a bit. It has become very much sort of a on demand type environment, where people are looking for same day treatments, people are looking for extended hours, they are looking for weekend availability, things like that, and they are looking for things which allow them for a greater convenience. So, scale allows you to do that, you are allowed more efficiency in scheduling, you're allowed more efficiency in provider utilization, which leads to better patient experience.

There always seems to be a push and pull on the growth strategies of growth through acquisition versus growth through De Novo locations. How do you think of that balance, when you're advising folks?

Great question. Obviously, there are lots of... The last icon, there were 136 private equity backed DSOs in the US, of all shapes and sizes, and across various different specialties and general dentistry and multi-specialty De Novo has been the holy grail. There hasn't been that many platforms of size and scale that have been able to perfect the De Novo strategy well, to be able to replicate it, but the ones who have done it have grown at a faster pace. The return on investment has been higher for them, and they've developed a niche for themselves in the market. With that said, though, we are typically seeing today, which didn't exist previously, is you either were a De Novo model or you were a M and A model and the two shall never meet.

But, today, we are seeing a mix of platforms that are deploying both strategies to get the best possible growth outcomes for their platform. So, even more so, where we've seen is strategies that are shifting our general dentistry platform that'll gain significant market share in a particular MSA or a particular market, they have nice density, enough patients coming into their five or six or seven, ten clinics in a pretty tight-knit marketplace, that then go ahead and open a De Novo only specialty location, which draws referrals from these ecosystem of general dentistry practices, which we've seen work really, really well. These tend to be very, very highly productive, highly efficient, great patient service. At the same time, allowing a platform to deploy a strategy, which previously didn't exist.

The De Novo strategy also works if you get a certain amount of density in a market. You can overcome one of the barriers of doing De Novo, and that is kind of staffing and having dentists to serve it. If you've got a sufficient amount of density, you can draw from staff and dentists at existing locations in that market, outfit a De Novo, which makes the idea of a De Novo a lot more accessible and a lot cheaper. So, there's a lot of synergies that can happen, once you get a certain scale in the market.

Absolutely. I think that's a very important point, and it goes to the foundation of a De Novo strategy, which is typically the way I've seen it is, you have established a location, which may have been a De Novo at some point. You've got two or three dentists or providers working in that location, all of a sudden, you want to open a location 10 miles outside of that radius, and you look at one of the two or three dentists in your existing location and say, "Hey, would you like to go lead this new location? You know the systems, you know the processes, you know the protocols, you know exactly how the De Novo or the office works, we'll staff it up for you." That consistency and that replication is what makes De Novos very successful.

When you think about a consolidation strategy, you're usually starting with the small things that sell to bigger things, and then those bigger things either continue to buy more small things or do De Novos, but then they sell to say a larger PE platform, who might grow it through the same sequence, and then sell it to an even larger private equity platform. Eventually, you get to the point where you have larger platforms. From where you sit, what is the health and prospects of those larger platforms? Because in the market they've been a little bit more mixed.

We have to look at the last few years in combination and in perspective of what exactly has transpired. COVID was clearly a big jolt to the dental ecosystem, because locations or offices were closed for a pretty extended period of time, and the market saw quite a bit of retraction, in terms of overall spend. But, the good thing is that the market also has bounced back, and we've seen things like the great resignation, and then the wage inflation and shortage of staffing, and shortage of hygienists and dental assistance. So, there's been a lot of operational headwinds that this market has seen, and despite that, and the fact that they have not experienced the pay rate increase that other markets or other sectors in the economy may have, in terms of pricing increases, et cetera, dental industry is very, very resilient, and they have done an extremely good job of managing through these hurdles or managing through these headwinds.

As it comes to some of the larger organizations and larger establishments, in the space, as I mentioned at the top of the conversation here, there still isn't one player that accounts for 10% of the market, and it is highly unusual to see $150 billion market, which doesn't have a public company to name off. So, we do think there are many larger DSOs that could be viable candidates, once the equity markets open up in the near future, that could potentially look to the public markets as an option for next chapter of their growth phase.

Consolidation strategies often have tailwinds, whether that is things that you can do with scale or multiple arbitrage. There are reasons why that model works, they're not devoid of headwinds. In the context of dental platforms, what are some of the risks and headwinds that you see for these platforms?

There have been a fair number of consolidations of consolidators that has taken place, obviously not at the same volume as private equity investments or sale to private equity, subsequent private equity funds. That has obviously been the larger piece of the pie here, but one example I'll give you is 123Dentist, which is second-largest DSO in Canada. They merged or they acquired Ultima Dental, which was at that time the third-largest consolidator or DSO in Canada. I think the biggest headwind that any human capital focused organization will face is around culture and making sure that you keep intact or at least have enough of a common ground between the two organizations, from a cultural perspective, that you won't break the foundation of one for the benefit of the other.

Where we've seen these things not work out, is where the leaders of the [inaudible 00:11:48] organization, the people who are making decisions and or people who are on the ground are not being accounted for, from a cultural perspective, that they have built something that needs to be preserved. A good example of a cultural mesh that worked really, really well is the merger of Northeast Dental Management with DCA back in 2016. It felt like the leaders of both organizations saw eye to eye, it was a great complimentary addition to the DCA platform, from a geographic perspective, from a service risk perspective, from a payer mix perspective, to end there were multiple synergies that they could realize both from a revenue and from a cost side. So, it was a win-win for all folks involved and has worked out really, really well, in that case.

Going back to the pure play specialty dental platforms, like you, I've seen a lot of activity in a number of those sub sub-sectors. Those have always struck me at one level, as being a defensive maneuver by those groups of specialists against the multi-specialty platforms, where like you said, you can have the specialists just housed within that platform. How do you think of that competition, and do you think it's true that the multi-specialty platforms ultimately will have the upper hand in some of those calculoses, given that as consolidation continues, there'll be an increasing ability to pull some of those referrals into those multi-specialty platforms? Or, is the playing field a little bit more balanced?

The growth or the birth of the specialty dentist dental platforms is a result of what the patients are actually looking for, from an experience perspective, from an outcome perspective, and also from what the providers really want to do, where they want to practice, who they want to practice with. I think both those things have driven the growth in these, especially dental platform. I think there's clear value proposition in these platforms. If you're an oral surgeon and you're dealing with oral surgery patients all day long, and your systems, your protocols, your physical location, your physical office is designed to serve those patients in a manner that drives the best patient experience and the best patient outcomes, going to deliver a better service, you're going to deliver a better product, you're going to shine against others that are more multi-specialty in nature. That's where the market is moving.

These smaller markets, albeit, or these subspecialties may seem small, but if you think about orthodontics, it's a $17, $18 billion annual market. You think about oral surgery, it's a $15 billion annual market. You think about endodontics, it's somewhere in the similar size range, so these are not small markets and these are even less consolidated than what you would normally think about the overall dental market. I would say oral surgery is less than 10% consolidated, same, similar for endodontics and I would say orthodontics is somewhere between 5% and 10% consolidated.

They're not trying to upset the apple cart, when it comes to the general dentistry practices, most, if not all of the specialty practices that I have dealt with or interacted or work with, they're very, very focused on making sure that the referral base they have through general dentists, that patient goes back to the general dentist on an ongoing basis to continue that relationship. This is merely a function of the fact that they want to make sure that that patient and that general dentist has the confidence in driving the patient to the best possible provider for that particular procedure.

Yeah, I think four or five years ago, I would've thought that the upper hand would go to the multi-specialty, but you're absolutely right. That's not how it's played out and the amount of scale you have to have in a market to have a really high-end specialty practice, just parked within a general dentistry or multi-specialty practice is immense, and the evolution of high-end, high performing specialty practices has been very resilient to that general dentistry consolidation.

Yeah, it goes back to your comment about scale. So, if I'm an oral surgeon working with three other oral surgeons, in an office which has six operatories, I have my own technology platform that is built for the oral surgery subspecialty. I have my own lab network or my own lab connection, which is geared towards catering towards my needs for my patients, for my specific procedures, around implants, et cetera, and it creates environment where my operations, from a scheduling perspective, an efficiency perspective and staffing perspective makes it that much more simpler and streamlined to deliver a service in highly efficient manner.

If you are in a multi-specialty practice, you're not going to see the same amount of volume and you won't justify the cost of doing all those specific things, from an ops perspective, for an oral surgeon who's only seeing one or two patients a day, versus a oral surgery practice that is seeing 50, right? So, it again, goes to economies scale and the fact that scale does allow you to deliver a better patient experience.

Let's turn the lens forward. I know this question will be impacted by macro market trends, but also one specific to dental. From where you sit looking forward, and bankers usually have a little bit better forward vision, just because you're further down the road, with respect to pipeline than say a lawyer like me would be. What does the prognosis look like for 2024, and in general for provider services, and dental in particular, to the extent that you think it's a little different?

Because of what's happened in the last 12, 18 months, especially as it relates to provider service businesses that are focused on the M and A strategy, the interest rates have gone up quite a bit, which has put a little bit of a damper on add-on activity, whether it's because of availability of financing, whether it's interest rates that are making it difficult for people to execute on their M and A strategies, the bar has moved and it's become a lot higher than what it was 12, 24 months ago. People are very much focused on making sure that they're scrutinizing their add-on activity or the add-on pipeline a lot more than they used to, simply because they know that they don't have the push or the margin they previously did, where the environment interest rates would lower. So, they're clearly focused on making sure that if they're going to make a bet on a sizable add-on and keep continuing on the consolidation play, they need to be able to grow that.

So, organic growth, both on the top line and on the bottom line is paramount, and on top of everybody's mind. I think those pressures were pretty acute in 2023, because of increases in, as I mentioned in wages the last time I was doing this analysis recently on a couple of DSOs that have worked with closely, and I kind of saw what the average increase in wages as a percentage, absolute percentage for a hygienist has been in the last two years, from 2021 to 2023, it's been nearly a 20% increase, and that's a pretty meaningful increase for a physician in a dental organization, which is staffed pretty heavily and drives a lot of patient volume. So, that's been a challenge in 2023, which has put a fair amount of margin pressure on the overall landscape. That coupled with a higher interest rates has basically slowed the growth down for folks and making them look internally to optimize their operations.

I think that is easing in Q4. We are seeing volumes coming back up as well. I think 2024 will be a much better year from a comp perspective. 2023, in many ways, was a reset year or rational in normalization year. I think 2022 was one, where coming out of 2021 where comps were really, really high, it was a little bit of a slower year, as well. But, going forward, we feel like the M and A activity will continue in this market simply because of the fact that there are that many private equity backed investor backed platforms, they have to grow and they have to employ some strategy or tactics, in order to continue the path forward.

We will continue to see M and A activity. We will see continue to see M and A activity and valuations hold up for premier assets that are differentiated in their niches, whether it's geography, whether it's specialty, whether it's how they're growing M and A versus De Novo. That'll continue to happen and I feel like there will be a better organic growth year in 2024, relative to 2023, where the pricing may come into play as well, alongside the volume.

There's also a lot of private equity funds, that even if they don't have the most differentiated and market niche focus, there's still a lot of platforms that have been in a portfolio of a private equity fund for 4, 5, 6 years, and there are some natural pressures that are looking for release, and I think that's going to drive a fair amount of activity, even if they're not all the prettiest kits.

We saw this in the dermatology space, a few years back, where the valuations for add-on acquisitions, the pressure there was a little bit different. Valuations for add-on acquisitions got a little out of hand, and all these companies built all this massive infrastructures to support all this growth that they were anticipating. Because of this valuation mismatch, they weren't able to grow as fast as they thought they would, which resulted in a fair number of what I would call as cashless mergers of equal, which allows them to rationalize their cost side of the equation, combine the revenue side, and make it a much bigger organization, and then essentially, compete in a market, versus against each other together in the overall landscape. I think that is definitely something that we have seen happen in other provider services, and we think that could also happen in the dental space.

KG, we could talk forever on this. I think we'll call it a day there. It's always great to chat with you. I've been wanting to have you join the Corner Series at your new place, and thank you for joining. It's been a ton of fun.

Yeah, thank you, Geoff. I always enjoy talking to you. Thank you.

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@McGuireWoods.com. We look forward to hearing from you. This series was recorded and is being made available by McGuire Woods for informational purposes only. By accessing this series, you acknowledge that McGuire Woods 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 McGuire Woods. 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.