This week The New Criterion drills down into the listed dental sector, which has just expanded by one-third with the listing of a new practice consolidator
Smiles Inclusive (SIL) $1.04
The unwritten law of the dental industry is that practice consolidators must incorporate “smiles” into their name, a catchy and upbeat reference to a visitation most clients associate with pain – hip pocket and otherwise.
But let’s face it, even medical professionals need to market their wares in the best possible light, especially when most of the population would rather hose out a putrid wheelie bin than front up for their annual check-up.
So smiles it is for Smiles Inclusive, which joined Pacific Smiles (PSQ, $1.70) and 1300 Smiles (ONT, $6.37) in the ASX ranks after raising $35m at $1 a pop.
Despite their homogenous monikers, we detect some differences in strategy and style between the trios.
1300 Smiles founder Daryl Holmes prides himself as a practising dentist who dons the drill one day a week.
“While that’s not everything, it certainly counts for something,” he says.
In contrast, Smiles Inclusive's Michael Timoney is an unashamed marketer, focused on getting bums on seats.
“I position us as a sales and marketing company that does dentistry,” he says.
Trading as Totally Smiles, Smiles Inclusive has contracted to acquire 52 practices nationally and aims to have 100 under its banner within a year.
That’s all well and good, but with other consolidators in the market as well – and not just the listed ones – there’s a danger of overpaying.
In 1300 Smiles’ half-year report, Dr Holmes referred to other operators paying over-the-odds prices.
“When others are acquiring practices for silly amounts, we simply step back and let someone else do the buying.”
Timoney concurs the market has hardened in favour of the vendors. Smiles Inclusive is paying an average of five times earnings before interest and tax, which compares with 3-4 times when the company started amassing its portfolio.
Fancy cosmetic dental practices are changing hands on a multiple of seven times. For the time being, Smiles Inclusive is avoiding these “rock star” practices and focusing on drill-and-fill general dentistry.
“With my CEO hat on I’m not prepared to pay any more, but five times earnings is a fair and reasonable price,” Timoney says.
Broadly speaking, the three companies tread the same path of acquiring practices from baby-boomer dentist getting a bit old in the, er… tooth.
But Smiles Inclusive’s business model differs from its peers, in that practice owners who sell to the company can continue to hold some equity through a joint venture vehicle.
These vendors continue to operate the practice, paying Smiles a service fee for the digs and support services. Through the JV vehicle they can share in some of the profits and eventual capital gains.
Smiles Inclusive has also resolved to stick to mainstream locations in metropolitan city locations.
Unlike Pacific Smiles it’s avoiding large shopping malls because he is not convinced customers want to combine a trip to the dentist with a grocery run to Woolies.
Unlike the others, Pacific Smiles has joined arms with the health insurers, with eight of its 75 clinics operating under the nib Dental Care banner.
The corporate dental model only makes sense if it can be more efficient than stand-alone locations, while retaining dentists at the same time.
Timoney’s productivity priority is to improve seat utilisation: of the 154 dental chairs being acquired, 61 are never used.
Sceptics of corporate dentistry argue the benefits are overblown because a dentist can only ever attend to one mouth at a time.
But Timoney argues every active seat improves economies of scale through shared reception and cheaper procurement.
According to research house IBIS, the dental market is worth $10 billion and revenues have been growing at 3 percent per annum.
As a non Medicare item, dentistry is mainly funded privately (or through private insurers) and is sensitive to economic conditions.
Despite the relentless march of the consolidators, dentistry remains a cottage industry: of the 7000 dental surgeries in Australia, the biggest owner (the health fund Bupa) accounts for only 6.5 per cent.
The real potential lies in persuading the 65 percent of adult Australians who don’t regularly visit a dentist. Given the cost and discomfort involved, this cohort will wait until black and rotting teeth force them to drop by.
1300 Smiles paved the way with a $1 a day dental scheme to address the affordability issue. Smiles Inclusive is trying to persuade corporate employers to offer dental incentives to their staff, in the same way they might fund a $300 gym membership.
Despite growing investor acceptance of the dental roll-up model, the Smiles Inclusive listing was struck on an earnings multiple of ten times – half that of its two listed peers. That’s because the practice acquisitions are yet to be completed and the company does not have a performance track record.
Personally, Timoney has form in the industry, building up the Dental Partners chain before selling it to the New Zealand-listed Abano Healthcare Group.
(Abano changed Dental Partners operating name to Maven Partners, which shows that a smiley title may not be mandatory after all)
Smiles Inclusive’s $64m market valuation compares with the $153m ascribed to 1300 Smiles and Pacific Smiles’ $256m worth.
The Townsville based 1300 Smiles reported half-year net earnings of $3.9m, on patient revenue of $28m.
Pacific Smiles reported a $4.9m half-year profit, on patient fees of $80.7m
Smiles Inclusive forecasts a full-year profit of $5.8m.
While wary of ratcheting practice valuations, 1300 Smiles and Pacific Smiles haven’t been idle with the cheque book, either.
1300 Smiles recently acquired orthopaedic practices in Chatswood and Bathurst, as well as five conventional clinics (including one ironically located in the sugar centre of Ingham).
Pacific Smiles bought Everything Dentures and Sculpt Lab in November last year. Overall the group rolled out 12 new clinics in 2016-17 and expects to expand by another ten in the current financial year.
1300 Smiles and Pacific Smiles haven’t had everything go their way: for instance, the removal of the federal government’s $1bn and widely rorted Chronic Diseases Dental Scheme, which left a revenue hole even the best composite resin filling couldn’t plug.
But 1300 Smiles shares have gained 700 percent and Pacific Smiles stock have increased 30 percent, since listing in March 2005 and November 2014 respectively.
Tim Boreham edits The New Criterion
Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.
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