A significant change to the new tax laws is the cap on corporate interest debt deductibility at 30% of earnings before interest, taxes, depreciation, and amortization (EBITDA).1 Companies maintaining excessive debt loads will likely face serious adverse tax consequences.
Many dental service organizations (DSOs) are highly leveraged with debt, as well as private equity firms that hold DSOs in their portfolios. These firms are almost always held in private hands and not publicly traded on exchanges.
As such, US Securities and Exchange Commission (SEC) rules don’t require public disclosures of company balance sheets. Outsiders don’t truly know which DSOs and their managing private equity firms have strong balance sheets, favorable cashflow, limited debt, and cash reserves on hand.
What This Means for the Dental Industry
DSOs and private equity companies that carry substantial debt loads in acquiring and maintaining dental practices will be forced to respond. As interest deductibility on debt sharply becomes more limited, valuations for dental practices may decline. Mergers of group practices and entire DSOs may diminish in value and frequency of occurrence.
Fewer potential buyers mean lower valuations. Unprofitable or less profitable dental clinics will most likely be divested for a steep discount, or simply closed down. The mechanism of debt leverage will be dramatically lessened as a tool to create, maintain, expand, and merge groups of dental practices.
Equity shares held by individual dentists in return for the sale of their practice, or purchased as a buy-in to an existing DSO managed clinic or clinics, may hold dubious value. Full disclosures on DSO financial records are only afforded by the rare publicly traded companies. It’s very unclear and uncertain as to the true value of junk-grade, privately traded equities, especially when that market is under stress.
The Golden Rule: Those with the Gold Make the Rules
Less profitable dental clinics may be forced to close. DSOs (and even individual dentists) that have cash reserves on hand will benefit. Office space with specific dental lease-hold improvements will be more available. Highly serviceable used dental equipment will glut the market, as it already does in numbers of demographics. Individual dental practices, as well as groups of clinics, may be expected to come onto the market at a steep purchase discount.
Well-managed and profitable DSOs will be better positioned to consolidate control of their industry over smaller upstart DSOs and less profitable DSOs, which are also often forced to borrow money at even higher interest rates. Even solo practitioners in some demographics will benefit, as corporate clinics face closures. A sharp influx of skilled dental auxiliaries may flood certain demographics, which may be available and retained at depressed wages.
The Bubble
Our government’s policy of quantitative easing has held interest rates for borrowers at substantially low numbers for years. Today, our economy is starting to heat up, and interest rates are beginning to tick upward. Higher interest rates for highly leveraged companies increase their cost of doing business and now also negatively impact their tax consequences.
A bubble in the DSO industry has been seen recently.2-4 Better managed DSOs, large or small, will definitely survive and probably grow in the aftermath of an industry shakeout. There will be winners and losers. Let’s examine one group positioning itself to possibly benefit from a DSO industry blowup.
Birner Dental Management Services (OTCQX: BDMS) recently received placement of $5 million in exchange for senior subordinate stock to Palm Investors.5 BDMS Inc operates a chain of dental practices in Colorado, New Mexico, and Arizona under the name Perfect Teeth. Prior to the cash infusion from Palm Investors, BDMS Inc was in default to its lender, Guaranty Bank and Trust, a Colorado bank.
New changes to tax laws on corporate deductions compound challenges for BDMS Inc. If management at BDMS doesn’t turn its financial ship around in a hurry, Palm Investors stands to potentially acquire operation of 68 dental clinics at a very steep discount.
Author’s note: BDMS Inc. is one of very few publicly traded DSOs. As such, the SEC requires company disclosures for investors, unlike a privately held company. The current financial distress of BDMS may or may not be reflective of the DSO industry as a whole.
References
1. Richter W. The GOP’s new tax law punishes the riskiest companies in America. Business Insider. December 24, 2017. http://www.businessinsider.com/what-trump-tax-law-means-for-companies-corporate-interest-expense-2017-12. Accessed February 10, 2018.
2. Salierno C. Is there a DSO bubble? Dentistry iQ. September 25, 2017. http://www.dentistryiq.com/articles/2017/09/is-there-a-dso-bubble.html. Accessed February 10, 2018.
3. Davis MW. Potential storm clouds on horizon of DSO industry. Dental Economics. June 1, 2017. http://www.dentaleconomics.com/articles/print/volume-107/issue-6/macroeconomics/potential-storm-clouds-on-horizon-of-dso-industry.html. Accessed February 10, 2018.
4. Giannini A. Is the DSO bubble about to burst? LinkedIn. October 21, 2016. https://www.linkedin.com/pulse/dso-bubble-burst-alex-giannini. Accessed February 10, 2018.
5. Birner Dental Management Services, Inc. Birner Dental Management Services, Inc. announces successful capital raise, debt restructuring and changes to board of directors [press release]. December 29, 2017. https://www.prnewswire.com/news-releases/birner-dental-management-services-inc-announces-successful-capital-raise-debt-restructuring-and-changes-to-board-of-directors-300575962.html. Accessed February 10, 2018.
Dr. Davis practices general dentistry in Santa Fe, NM. He assists as an expert witness in dental fraud and malpractice legal cases. He currently chairs the Sante Fe District Dental Society Peer-Review Committee and serves as a state dental association member to its house of delegates. He extensively writes and lectures on related matters. He may be reached at mwdavisdds@comcast.net or smilesofsantefe.com.
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