A Third Dimension – The Emergence of Specialty DSOs

Within the last 4-5 years, there has been a rapid emergence of investor-backed platforms focused solely on specialty-only consolidation. The vast majority of specialty-only DSOs are still very early in their life cycle, as is the overall consolidation movement within dental specialties. Understanding the advantages and disadvantages of these companies and their future growth is a key component of understanding the future of the DSO landscape.

Many of these groups have been built around a single dental specialty. Others have been built around multiple specialties that have a synergistic relationship (i.e. pediatric and orthodontics or pediatric, orthodontics, and oral surgery). There is also a competing model which incorporates general dentistry and dental specialties together. This combination brings all clinical areas into one group model and provides a broader network opportunity for doctor partners to work within for their patients, diversifies business risk, and allows for greater growth opportunities.

There are four core areas to focus on to help us foretell the direction and long-term sustainability of DSO consolidation within the dental specialties:

• Doctor availability
• Equity models
• Referral patterns
• Total addressable market

Doctor Availability 

We feel that financial investors have historically underappreciated the significance that individual doctors play in the success of a dental practice. This is changing, however, as investors become increasingly aware of the importance of aligning incentives with dentists and more sensitive to avoiding an exodus of retiring doctors within their growing groups. Sustaining doctor coverage over the long term is a risk to both GP groups and specialty groups alike, but specialty groups have a much smaller pool of doctors to choose from. Becker’s Healthcare Review recently published data from the American Dental Association, which highlights the number of active doctors by specialty.

Any doctor who has tried to hire a specialist already knows this, but the data paints a telling picture that the competition for specialist coverage is much more acute than within the GP space. Not only are the individual specialty markets smaller, but the supply of newly graduated specialists is also considerably smaller than that of general dentists. Doctor recruitment and retention will be a persistent challenge for all DSOs, but it will be an especially pronounced challenge for the specialty-only DSOs who must work within a much smaller field of doctors to recruit from. As the landscape changes and a new generation of specialists graduate, these doctors will have to make decisions on whether they want to be employed by a practice or take practice ownership (immediately or in the future). A limited number of specialists coupled with a lack of practice ownership has the potential to destabilize groups over time.

Equity Models

We covered this topic extensively in part II of this series. Our core belief is that any group that does not have a sustainable alignment model with its doctors will be challenged to succeed over the long term. Given the afore-mentioned small population of specialists, aligning interests with those doctors is critical to maximizing long-term retention. Doctor retention is the most important driver of same-store earnings growth, which is one of the core results DSOs will need to deliver. Most specialty-only DSOs have a “HoldCo equity model,” which gives doctors fractional equity ownership of the DSO (or holding company). As previously discussed, this equity model creates alignment at the DSO-level, but what remains to be seen is how future generations of employed specialists within these groups will be able to benefit from the same equity upside as the current generation of specialists who are selling their established practices. Specialists are highly trained and highly compensated for their work. Despite continued consolidation, we do not believe specialists will lower their expectations for the financial success that is attributed to practice ownership. Without practice-level ownership as a primary incentive, we believe the specialty space will shift to an employed-doctor model and make attracting and retaining specialists more difficult.

Referral Patterns

One of the greatest challenges that specialty-only DSOs will face well into the future is ensuring that they maintain their referral sources. Modern marketing capabilities have enabled some specialists to obtain patients through direct marketing (i.e. orthodontics and implant providers), but general dentists are still responsible for directing the majority of referrals to specialists. Any growth-minded general dentistry DSO will look for ways to grow by bringing more specialists into its general practices (not a new concept) or by acquiring specialty practices to build a multi-specialty platform (also not a new concept, but one that is building momentum with the increased market consolidation). In the post-COVID era, we have observed a greater focus by many general dentistry groups to add specialty practices to their platforms. If a group is successful in building market density with both general and specialty practices, then it can create a powerful value proposition for specialists by strengthening and solidifying those referral relationships. Within MB2’s own dataset, our general dentist partners referred over 135,000 patients to specialists last year. There is an incredible opportunity for MB2 to continue partnering with specialists so that both they and our general dentist partners can continue to work together clinically, and both benefit from more financial stability within their practices. One of the greatest risks specialists, both private practitioners and those affiliated with DSOs, will face over the coming years is ensuring they do not lose referral sources who sell their practices to a DSO. Specialty-only platforms will have to contend with that dynamic as a long-term systemic risk within their business. Multi-specialty groups that successfully combine general dentistry and various specialties in geographic markets will ultimately build a bigger economic moat around their business.

Total Addressable Market

“TAM” is a term that most dentists have never heard of, but it’s a concept that every investor is very aware of. Total addressable market is defined as the total revenue opportunity that investors have available, assuming 100% consumption of the services (or goods) within that market. In the case of dentistry, it implies the maximum size of each sector, assuming the entire patient population received the dental services that they need. Investors look at TAM to understand what their ultimate growth potential might be. The smaller the TAM implies a lower long-term investment opportunity. As DSOs continue to grow and consolidation advances, investors will become more keenly focused on the TAM that is available to them. The ferocious pace of M&A and the heightened multiples that we all see within the dental sector today are a direct result of investors seeing considerable fragmentation within dentistry, which has a very large total addressable market. The difference in the size of each dental specialty and the ensuing TAM is considerable when reviewed on a comparative basis.

Over the next decade, we will see all of the keys to DSO success become increasingly evident in the way DSOs operate. With much consolidation ahead of us, total addressable market is the most important variable in terms of thinking through DSOs’ ability to sustain consistent and long-term inorganic growth. Specialty-only groups will have a much smaller growth runway than general dentistry groups, and groups that combine both general dentistry and multi-specialty will have a massive growth opportunity that will sustain them long into the future.

Summary

The complexities that DSOs will face in the future will require flexibility, tenure, and the ability to provide consistent leadership. The model, growth strategy, or specialty area alone does not guarantee success. There must be an established infrastructure and know-how to thrive in a competitive and constantly changing market. These key traits cannot be built overnight. Having a successful hybrid equity model is dependent on attracting doctors who see the value of maintaining equity in their own business and investing in a partner business. It takes time to find these types of doctors who have substantial time left to commit to their practice and to the group. The ability to grow through both acquisitions and de novos requires two very different skill sets, which is why most companies opt for one or the other. Building these teams and playbooks (and refining them) also takes time. DSOs that can act on both acquisitions and de novos in parallel will benefit from the advantage of being able to manage the speed of their growth and the health of their balance sheet. They will have the flexibility to respond accordingly to market conditions, minimize their risk regardless of the state of the capital markets, and reduce long-term operational risk by driving both organic and inorganic growth. We hope that no matter what your position is within the DSO sector (practice owner, associate doctor, dental student, investor, vendor, banker, executive), this series of articles provides you with a framework to evaluate the current landscape and the future of the dental profession.