How to Profit Like a DSO

The basic strategy of the DSOs is to buy practices at one multiple and then sell them at a higher multiple. DSO’s buy from private owners or investor dentists (Investor Networks) with the intent of selling them to private equity groups, life insurance companies or pension funds.  Their intent is to profit from the ‘multiple spread’ which is the difference between the acquisition multiple and the disposition multiple.  They of course also profit from operations however the prime directive is to build it and sell it.  The schedule which follows illustrates how this could work for a DSO with 200 practices based on the assumptions in the schedule.

In order to get the returns set out above, the DSOs have to transform themselves into corporations and this is the biggest difference between DSOs and Investor Networks.  Investor Networks are typically smaller than the DSOs and what they lack are all the trappings of a real corporation, like CEO’s and CFO’s, HR departments district managers etc. etc.  Putting together the elements of a mature corporation requires a level of expertise and cost that exceeds the capabilities of most investor dentists.  Not withstanding the foregoing, there is a way for investor dentists to profit like DSOs.

The profit we are talking about comes from the application of the appropriate multiple to the current EBITDA.  The schedule below shows the history of a practice with an EBITDA of $350,000 purchased with a 5.5 multiple for $2.75M.  During the next couple of years, the owner hires a consultant and doubles the EBITDA (sounds daunting but is often doable).  Once the EBITDA is doubled, the practice is bundled with 5 or 6 other practices and sold as a bundle for an 8.5 multiple.  Based on a selling price of $8.5M, the profit from the transaction is $5.75M which is a 209% return on investment.  The DSO that buys the practice is able to increase the EBITDA by 25% and then sells the practice, along with all of its other practices, to a private equity firm for a 14.5 multiple.  The profit on the sale is $9.625M which is a 113% return on investment.  The investor dentist’s return is almost double that of the DSO with only a fraction of the effort.

The question of course is why would a DSO pay such a premium for a practice?  All of Canada (but particularly Ontario) has an abundance of desperate dentists, that is dentists who are desperate to buy a practice usually because they have tried unsuccessfully in the past to buy a practice.  Well guess what? the Corps are in kind of the same boat.  Investors have provided the DSOs with lots of cash on the assumption that it will be invested.  The DSOs are under lots of pressure to get that cash invested in dental practices.  By bundling half a dozen to a dozen practices together, it is possible to materially lower the DSO’s cost of acquisition.  By offering them to all of the DSOs it is possible to create a DSO bidding war because the DSOs understand that if they don’t buy, their competition will and they lose significantly.