Up until very recently, we were in the midst of one of the longest periods of economic expansion and growth in history. The recent bull market, which began in March of 2009, was going on for 11 years in duration and officially the longest bull market in history.
During the Great Recession of 2007, the dental industry demonstrated that it was virtually recession-proof and continued to thrive while other industries hovered on the brink of collapse. As a result, the end of the Great Recession of 2007 sparked enormous and unprecedented interest in the dental industry from non-dentist investors. This has led to the Great Evolution and Great Consolidation of dentistry, where dentist-owned solo practices and group practices are monetizing the value of their practices by affiliating with DSOs at a record pace.
This explosive M&A environment has created once-in-a-generation returns for sellers with EBITDA multiples for large DSOs and group practices routinely hitting the double digits, with some even exceeding 18X. To date, DSO market penetration sits at just under 25 percent, which leaves an enormous runway of potential continued expansion over the next 10 years.
However, based on historical data, it is virtually inevitable that another recession will occur sometime in the not–too-distant future and many in the DSO industry are wondering what effect a recession might have on the Great Evolution and Consolidation of the industry.
What is a Recession?
A recession occurs when there are two or more consecutive quarters of negative economic growth. Business sales, revenue and expansion generally decrease during a recession. The unemployment rate generally also increases during a recession. While recessions can be painful, they are often fairly short in duration.
Brent Little, founder of Odyssey Wealth, a leading financial and strategic planning firm to the dental industry, states:
“The average recession lasts 17.5 months and occurs every 4.7 years. The longest recession (The Great Depression) was in 1929 and lasted 43 months. The second longest was the Great Recession of 2007 which lasted only 18 months.”
Thus, historical data seems to suggest that we are long overdue for a recession but it will likely only last no longer than 18 months in duration.
Potential Risks of a Recession
Some of the potential risks of a recession to the DSO industry are:
- If patients will stop going to the dentist and harm practice revenues;
- If banks stop lending money to practice owners and investors;
- If private equity funds will be unable to invest in the DSO space;
- If practice owners will be unable to sell their practices during a recession; and
- How the timing and value of second equity events may be affected during a recession for sellers who have rolled over part of the purchase price for shares in the DSO entity.
Potential Mitigating Factors
The following factors might make a recession less painful for the dental industry:
- If, similar to the Great Recession of 2007, patients continue to go to the dentist and the dental industry, in general, thrives;
- The dental industry taps into its enormous growth potential to offset some of the harm caused by a recession (an estimated 60 percent of the population does not go to the dentist and represent an extensive untapped resource);
- Many investors conduct all-cash deals and do not rely on bank financing;
- The demand for dentists continues to outstrip the supply of available dentists which makes mass unemployment of dentists unlikely; and
- Most recessions last less than 18 months.
Conclusion and Analysis
Based on the available historical data, and a review of the likely risks and mitigating factors present in the dental industry, it appears that:
- A recession is overdue to occur sometime in the next one to three years;
- A recession will likely last for less than 18 months;
- Current DSO organizations that are struggling or are only marginally successful may be financially vulnerable;
- Some lenders may scale back their lending activity or become more selective during a recession, but it is unlikely that the lending markets will completely collapse as they did in the Great Recession of 2007;
- Some investors may scale back their activity during a recession while others will use the recession as an opportunity to conduct all-cash deals and achieve above-market return;
- Strong financially-sound practices should still be able to be bought and sold during a recession, but at a potentially reduced multiple;
- Weaker practices may have to postpone an equity event until the end of a recession; and
- Practice owners who previously sold and rolled over part of the purchase price in shares of the new DSO entity may receive a lower-than-anticipated return if an equity event occurs during a recession, or they may see the second equity event postponed until the recession is over.
While no one can state for certain when the next recession will hit, there are a few things you can do to prepare for it now. Brent Little recommends that:
- On a personal level, you should have one to two years of available cash for short term needs;
- On a personal level, you have a diversified portfolio that can withstand a 10-30 percent drop in the stock markets; and
- If necessary, you can postpone an equity event for 18 months to two years if necessary.
Overall, the dental industry remains very strong and if history is any indicator, it seems unlikely that any negative effects from a recession will last more than a relatively short period of time. Over the next seven to ten, years, the great consolidation of dentistry is likely to continue mostly unabated with many commentators predicting that DSOs will comprise upwards of 80 percent of the market by 2030.
Written by Brian Colao, Director, Dykema Dental Service Organizations Industry Group
Brian Colao is widely regarded as one of the foremost authorities in the United States on DSO formation, DSO business structures, DSO related mergers and acquisitions, and the full array of regulatory compliance requirements for DSOs. In 2019, Brian was selected for inclusion in Group Dentistry Now’s “2019 DSO Influencer’s List.” He was just one of seven individuals chosen for the publication’s inaugural list and was the only attorney to receive this recognition. Read Brian’s other article, Now and Then – an Analysis of Current and Past DSO Models.
Don’t miss seeing Brian at Dykema’s 7th Annual Definitive Conference for Dental Service Organizations, July 15 – 17, 2020 in Dallas Texas at the Omni Dallas hotel. It is an immersive event which offer topics carefully selected to appeal to all facets of the DSO industry, including buyers, sellers, practice owners, executives, entrepreneurs, investors, DSOs and in-house counsel. Use code GDNOW20 for $150 off registration.
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