Dental Practice Valuations, Independent Dentistry - May 2003

May 1, 2003

Independent Dentistry - May 2003

DENTAL PRACTICE VALUATIONS

NO SERVICE IS CHEAP ENOUGH IF IT FAILS TO DELIVER WHAT IS REQUIRED

There have been significant improvements in oral health over the last two or three decades. There are fewer and fewer numbers of edentate people and an ever reducing demand for traditional prosthetic products. One could think that the dentists' days are numbered.

In fact, the very opposite is likely to be the case, as people keep their teeth for longer and become more aware of the increasingly wide range of treatment choices and products.

As skilled as dentists are, they are increasingly reliant on good laboratories to provide added value, through the availability of high quality dental products. Technological advances are such, that at last the laboratory sector is moving away from its traditional cottage industry image.

Technicians are becoming more inventive, and via the use of modern communications, product is readily offered from all around the world. We now can enjoy sophisticated veneers and crowns, such as Procera from Sweden, and colour matching that adjusts to the colour of surrounding teeth.

In orthodontics, there has been a dramatic breakthrough with a product called 'Invisalign' which is an appliance that is automatically self-adjusting by means of computer chips placed within the unit. Such items are not cheap, but people are prepared more and more to pay what it takes to look good.

In the past, people only went to the dentist out of sheer necessity, and over half of us stayed away out of sheer terror! Even now, around 40% of the population only visit the dentist when they absolutely have to and for these people dental treatment only takes place once every five or so years.

Unfortunately, for many of these, by the time they go they face a programme of sometimes quite radical work. Such a situation could often be avoided with better targeted funding, more innovative delivery methods and improvements in the level of financial assistance for those that cannot afford it.

Overall, it is reassuring to know that circumstances are changing rapidly. A major cultural shift has been encouraged by the arrival of more female practitioners, by proportion, in the General Dental Service. More recently, Government pilot schemes have been launched to seek out how best to improve the GDS, reflecting appreciation of the causal links between oral and general healthcare.

With this increased awareness of the importance of good oral health and dentistry as an essential part of everyday routine, dentistry has become 'big business'. In September 2000, LCS estimated that the total dentistry market had an annualised value of about £2.85bn.

Within this total, the portion of dental treatments funded through the NHS has been falling, whilst private treatment has been rising in the last five years by 8.5% compound per annum and now represents 25% of the volume (and one third of the value) of work undertaken.

Not only have consumers become increasingly aware that top quality work is only available privately as government funding falls well short of required levels, but dentists themselves have also become increasingly reluctant to work on in what they perceive is a constrained NHS.

Against this background of change and opportunity several dental body corporates, who are large practice management groups, are looking to expand substantially. This in turn is attracting a much needed capital injection provided by institutional investors.

Health Clinics Plc, J.D. Hull & Associates, Ora and Boots plc in particular, are in the process of bringing dentistry to the High Street, making access and availability considerably more convenient for the consumer. With the emphasis on dental care shifting to preventative and elective surgery increasingly involving hygienists and other professions complementary to dentistry, and away from radical mandatory treatments, dentists are under pressure to keep up with changing demands and methods of delivery.

As the dental corporates expand, and the requirement for investment in both staff training and equipment increases, the smaller traditional one and two chair practices will struggle. These practices will either be assimilated by larger groups, or they will have to form strategic partnerships to compete. Such consolidated practices may also well present themselves in due course as attractive acquisitions for the corporate groups.

In this context, it is vitally important that dentists are properly advised on business and commercial issues. Just as dental professionals have to keep up to date with latest technological developments and techniques, and have to be able to identify the best suppliers of the best dental products, so their advisers have to be at the cutting edge of business practice.

Many advisers have not changed their approach, despite dentistry businesses finding themselves in an entirely different environment today. For example, the established dental valuers are currently falling well behind in this regard. Few, if any of them, are professionally qualified and most employ outdated techniques that have no place in the modern commercial world.

Maybe change is on the way. Sophisticated new market entrants, some of the leading dental corporate bodies, financial institutions and a number of lenders to the sector, now believe that they should no longer accept a second rate service. What is more no service is cheap enough if it fails to deliver what is required.

Users of valuations will increasingly demand accurate detailed data that is well researched and reliable. They will rightly insist on a service that facilitates their decision making processes on acquisitions, mergers, restructuring and overall risk management. They will also ask for reports that are articulated in a way that assists them in comparing competing projects, to properly assess investment opportunities and satisfactorily provide additional analysis to support putative loan facility agreements.

There will be an increasing demand for the use of discounted cash flow (DCF) techniques, the industry norm for all major healthcare investment decisions ? with specific and detailed cash flow over, typically, a ten-year period ? as a coherent and explicit method of arriving at market value.

The concept of the approach commonly used by many valuers to valuing a practice based on a rudimentary "valuation" of goodwill, based on a percentage of turnover, and an addition for the real estate value on an alternative use basis, would appear antediluvian in any other sphere of business activity.

There is a real risk that dentists, particularly those with large private client lists will be the losers from such procedures, because their practices are more likely to be undervalued using these methods. By implication, this will be to the detriment of the patient, as dentists will be less able to raise the necessary finance to keep up to date. In fact empirical evidence suggests that this has already happened in many instances.

Assuming a positive outcome from a clinical audit, a valuation of a dental practice needs to reflect what level of cashflow the business can generate in the hands of an averagely efficient practitioner. The only way to assess this systematically is inter alia to review demographics and competition in the catchment area and build a financial model that computes revenues going forward, changing employment conditions and non-payroll costs, and also factors in annual maintenance capital expenditure.

These cashflow forecasts and the discount rates applied, will not only reflect the analysis of other transactions and the time cost of money, but also give an assessment of the quality of income flows in the business.

In the view of LCS the valuation of dental businesses requires access to intelligence on market fundamentals. It needs an appropriate analytical framework. It must also have a team of dedicated multi-disciplinary professionals who can properly address all of the key questions on values by analysing the direction of the markets in the short, medium and longer term.

LCS clearly sets out to practise what it preaches. No doubt that in due course more firms will follow their lead, including those who already practise the same techniques in other sectors. Some of the others maybe ought to consider their raison d'etre. No dentist should need in future to rely on any back of the envelope approach.