The DSO – dental service organization – industry was going strong before COVID-19 struck, with many believing it was immune to cyclical forces and big-picture events. But things have changed. Stay-at-home mandates, social-distancing restrictions, and other measures aimed at limiting the spread of the disease have had a far-reaching impact on DSOs and their dentist partners.
As in the healthcare sector more broadly, the demand for non-pandemic and non-emergency services has fallen sharply as Americans either chose or were required to postpone elective procedures. At the same time, medical and dental providers have been faced with rising expenses, including the costs of buying extra personal protection equipment and maintaining temporarily closed offices.
Not surprisingly, many have sought to make up the difference by raising fees. Unfortunately, based on our discussions with clients and what we hear in the marketplace, these changes are being driven more by front-line healthcare professionals than CFOs. Our sense is that there isn’t a clear-cut understanding of how various developments are affecting the bottom line.
Preparing for a less certain future
That said, some are looking to gain a better handle on what is going on. At E78 Partners, a number of clients have asked us to conduct in-depth analyses aimed at evaluating spending and pricing changes to see how they are affecting margins, profitability and operational viability. We are drilling down into revenues and expenses to identify ways to mitigate the financial impact and pinpoint opportunities.
One question many clients are asking is whether the changes that have occurred should be seen as temporary or permanent. Will people only care about these issues, say, during the next 12-18 months, or will COVID-19 adjustments become the norm. When it comes to the clinical advisory boards we speak with, many maintain that what we have now is the way going forward. Nevertheless, given the high degree of uncertainty, we remain focused on evaluating a range of scenarios.
A pickup in distress
Regardless of what the future holds, recent events have undoubtedly forced the hand of some DSOs, many of which are owned by private equity firms. Until this year, most seemed to think that the only way for the industry was up and they invested heavily in building infrastructure to accommodate ongoing expansion in affiliated practices. Now that the acquisition engine has been turned off—or, at the very least, paused—a disruptive industry is experiencing some disruption of its own.
In reality, cracks had already begun to appear in the DSO space before the crisis, leaving some operators on shaky ground. But over the past few months, there’s been a noticeable pick-up in DSOs that are in financial distress. More recently, we’ve seen busted loan covenants, increased staff turnover, and lenders taking over firms and trying to sell them off on a piecemeal basis.
Amid questions about the right strategy going forward, lender-led “carve-outs”—which often involve a uniquely complicated set of issues—and declines in the managerial ranks, we’ve seen interest from two segments: those on the wrong side of the downturn and those seeking to capitalize on what they see as a temporary hiccup. But as with the DSOs mentioned earlier that want to know the bottom-line implications of recent developments, we’ve also seen growing recognition that the right answer is to bring us in.
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