UK Dentistry Consolidation....A Rapidly Changing Industry!

UK Dentistry Consolidation ...a clear sign of a changing industry!

{!firstname_fix}, it was only a matter of time before consolidation in the UK dental corporate sector hotted up, now with private equity firms vying to buy Oasis Healthcare under the nose of ADP.

It was only around eighteen months back that Oasis's share price was languishing around 13p per share, but with the latest round of bidding each share is now valued at around 94p per share. So for any shareholder it is bonanza time. You can see the performance of its share at the following link: http://www.oasisdentalcare.co.uk/investors/shares/

So what has got ADP and Duke Capital (the private equity firm) so excited about Oasis Healthcare? Well, with my former equity analyst hat on, I am not too sure. The last set of Oasis's accounts are to the year ending 31 March 2006, and they are not particularly attractive. So could they have transformed their business around in the space of a year? It's unlikely, but I guess stranger things have happened.

I read Duke Capital believe that Oasis has been capturing NHS contracts around the UK whilst the average dentist has been giving up their NHS contract - perhaps this is true, but haven't Duke Capital wondered why those dentists have given up their NHS contracts in the first place?

Yes, Oasis has some economies of scale and perhaps is signing up new contracts across the UK, but firstly, as you and I know, these contracts are only 3 years in duration, so what happens then? Perhaps PCT's will re-commission contracts perhaps they won't? But should any buyer be buying the Oasis business based on this premise?

My days as an analyst taught me share valuations are based on the discounted future earnings of a business. Do the buyers genuinely think that the price they are paying for Oasis is a fair reflection of the future earnings of the company. Perhaps they do. However, contracts negotiated in 2006 with PCT's, as you and I know, may differ considerably in 2009.

Valuation Approach

Using a valuation technique used commonly in the city (Enterprise Value/EBITDA) I can work out from the limited information in last year's accounts that the company is valued at around 15x EBITDA, similar companies in the healthcare sector ( or those as near as possible to this) trade around 14-15x EBITDA. So on that basis it shows that 94p/share is fair purely based on technical valuations. (This maybe a little accounting technical, but if you want to know more let me know).

(Please Note: Enterprise Value - is Share Market Value plus Net Debt; EBITDA - Earnings before Interest Tax Depreciation and Amortisation)

So the value for Oasis appears fair in respect of market valuations, however, in my opinion it does not really take into account all the factors detailed above. In particular, the 94p/share price does not really consider the fact the NHS contracts are only 3 years in term, not indefinite. Or perhaps they know something we do not know? Ultimately, the price will be determined not only by market valuations but also by simple economics - i.e. how much is a buyer willing to pay for the business? Every buyer has a different threshold they will not go above, as they will have differing opinions on what they can do with the business.

Whoever ends up buying Oasis will end up with a chain of practices in over 130 locations around the UK. A close look at the year ended 31 March 2006 accounts also shows that they have very little freehold property and their leasehold properties have a net book value of just under £6m, so the scope for the buyer to buy Oasis on the cheap and then revalue the properties and then sell them at a nice profit is pretty slim (a la Phillip Green style when he bought BHS - if you have not already read Top Man - a very interesting read).

The ultimate winners in the process will be the long term shareholders of the business. Looking at the list of directors with their interests in Oasis, plus the share options they also hold, they appear to be the winners in the whole process. If my calculations are correct, they will be netting quite a lot of cash between them. The whole process may be further delayed as on close inspection of the accounts one of the directors will be able to exercise a large part of his options only after 2 August 2007, at a price of just 16.25p. This means he can buy the shares at 16.25p, whilst the offer on the table is 94p/per share....lets see what happens here! A clever tale of how to run a corporate and NOT be run by a corporate!

I imagine the Oasis directors had planned their exit routes well in advance, planning to turnaround the business in the short term by securing NHS contracts, thereby increasing the value of the business, and then getting a decent value for the business upon sale. Pretty smart thinking really.

So what about the future?

I doubt things will change significantly for dentists and team members at each location, further consolidation within the practices, and a drive to increase profitability will be the main focus of any acquirer - how this will be done remains unclear to me. I do hope the new owners will be able show that corporate dentistry is here to stay and that better margins can be achieved in the long term for dental body corporates.

For me, the main lesson that can be drawn from this whole exercise is that with the changes in legislation last year in dentistry allowing more corporates into the sector, I feel we will start seeing more corporates enter the dental field. They will have observed the mistakes made by other corporates, and then also perhaps develop very different business models making the dental sector potentially even more interesting and exciting.

Some of these corporates will be set up on a large scale, with economies of scale. You may have heard some of this before, but it probably will become more like the optical market, whereby there are some large well known players who have a significant share of the market, and do have some power on dictating the profit margins available. This will therefore mean practices having to adopt a much more commercial focus as dentistry becomes more corporate.Now who said UK dentistry was dull?

Please note all of the above commentary are just my views and the information gained has come from public records.

If you have any questions or thoughts please get in touch with us, our team is always here to help!

Best regards,

Arun Mehra ACA

Managing Director

"Helping Dentists Build Better Businesses"