Westcove

Oral Surgery Industry Insights

Market Trends and M&A Activity
February 2021

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Executive Summary

Introduction

Since first seeing private equity investment in 2018, oral surgery has emerged as one of the most sought-after sub-specialties of physician practice management for investment by private equity sponsors. Oral surgery’s extreme fragmentation, and high margin services, among other reasons, have continued to drive investment activity in 2020 and a continuation of this trend into 2021 and beyond.

Consolidation in the oral surgery sector is following a similar pattern to other physician specialties (dermatology, ophthalmology, gastroenterology, etc.), wherein a first-mover investor establishes a platform organization in a key geography and seeks to establish regional dominance through add-on acquisitions of smaller practices. Following the success of the initial platform, additional investors then establish competing platforms in new geographies until a saturation point is reached. Presently, there are five private equity-backed platforms. Westcove believes this may figure may grow to eight to ten over the next one to three years before existing platforms pursue secondary recapitalizations (“second bite of the apple”). In addition to new private equity sponsors seeking platform investments, existing platforms will continue to expand via add-on acquisitions of smaller practices in local and regional markets to broaden and solidify their market presence across the United States.

In the following piece, Westcove will highlight the key trends driving consolidation in oral surgery, summarize recent consolidation activity, and detail why the first half of 2021 may offer a compelling time for founders and executives of oral surgery practices to consider a capital raise, acquisition, or private equity investment.

Consolidation within the Industry

Prior to discussing the trends driving consolidation, it is important to note the significant transactions that have occurred within this past year alone. Despite the economic impact of COVID-19, oral surgery transactions have continued at a flurry that will likely last well into 2021 and 2022, as recent merger & acquisition activity has drastically reshaped the industry landscape. Acquirers have prioritized well-managed and productive organizations with leading reputations in their local communities. Much of the transaction volume during 2020 was driven by the geographic expansion of existing platforms such as U.S Oral Surgery Management’s acquisition of Oral and Maxillofacial Associates LLC in Oklahoma, but two additional platforms were created in the fourth quarter of 2020. In October, Dune Glass Capital partnered with Fort Worth Oral Surgery (TX) and Evergreen Oral Surgery (CO) to form Allied OMS, and in December, Blue Sea Capital made a landscape-altering investment in both Atlanta Oral & Facial Surgery & Bay Area Oral Surgery Management to form Beacon Oral Specialists. Below is a summary of the most recent platform transactions that occurred in 2020:
Private Equity Interest in Healthcare
Consolidation Trends in Specialty Physician Services
Consolidation in the healthcare industry has been driven by multiple factors: the aging of a relatively wealthy baby boomer population, an ever-evolving regulatory environment, reimbursement changes, technological advancements, and massive fragmentation in numerous specialty physician services verticals. Much of the consolidation in various healthcare verticals has been driven by private equity. Private equity firms employ a series of investment strategies, but most relevant to this discussion is the “roll-up” strategy. The strategy begins through a partnership between a private equity firm and a leading practice that possesses clinical excellence and often a talented management team that is committed to long-term strategic growth, and a scalable operational infrastructure: a “platform” investment. Once additional internal investment is made to optimize the platform organization, the private equity firm will seek to acquire smaller add-on physician groups at valuations significantly lower than that of the platform practice.
Through integrating add-on acquisitions with the larger platform investment, the company achieves “multiple arbitrage.” While the platform organization will continue to increase revenue and EBITDA (earnings before interest, tax, depreciation and amortization) organically, adding revenue and EBITDA through add-on acquisitions can expedite the platform’s growth. Since larger organizations (with larger revenue and EBITDA bases) typically receive higher valuation multiples, the platform organization will typically receive a larger valuation multiple upon a secondary recapitalization, or “second bite of the apple” than the multiples paid for both the platform and add-on investment, an example of which is demonstrated below.
Sample Overview of Multiple Arbitrage

The above chart illustrates the value created through multiple arbitrage:
– A platform oral surgery practice with $5 million of Adjusted EBITDA is valued at a 10.0x multiple in a private equity transaction, resulting in a $50 million valuation.

– Leveraging the expertise of its private equity partner, the platform acquires another practice with $2 million of Adjusted EBITDA at a 7.0x multiple through an add-on acquisition. This transaction is valued at $14 million.

– Through payor synergies and operational efficiencies with the platform, the acquired practice is able to generate an additional $500 thousand of Adjusted EBITDA per year that accrues to the platform at the original 10.0x valuation. This creates an additional value of $5 million.

– As a result of the multiple arbitrage of 3.0x (10x – 7.0x) between the platform and the add-on acquisition on the original $2 million of Adjusted EBITDA, there is an additional $6 million of value that is created through the partnership for the platform entity.

Oral Surgery Macroeconomic Trends
Demographic and Macroeconomic Trends Shaping the Oral Surgery Industry

Westcove believes that demand for oral surgery procedures will increase in the foreseeable future. This increased demand is driven by numerous factors, namely an aging US population, the prevalence of oral cancer, dental caries and periodontal disease within the geriatric population, and growing disposable income which is predicted to translate to an increased willingness to spend out-of-pocket for medically-necessary oral surgery procedures, and cosmetic dental procedures.

Aging Population: The average age of the US population continues to increase at a steady rate. Today, there are 46 million adults in the US that are 65 years or older. By 2050, the number of adults over the age of 65 is projected to double to approximately 90 million. Between 2020 and 2030, the number of elderly people is projected to grow by 18 million. This is due to the baby boomer generation; in 2020 to 2030 the remainder of the baby boomer generation will reach the age of 65. Put more simply, by 2030 1 in 5 Americans is projected to be 65 years or older.
Prevalence of Oral Cancer, Dental Caries and Periodontal Disease in the Geriatric Population:  According to the American Cancer Society, over 53,000 people will be diagnosed with oral cavity or oropharyngeal cancer in 2020, and the average age of the patient diagnosed is 62; these numbers are expected to grow steadily for the foreseeable future. Additionally, a study conducted by the National Institute of Dental and Craniofacial Research in 2004, and reviewed again in 2018, identifies a high percentage of elderly people with permanent tooth decay, missing or filled permanent teeth, untreated tooth decay and periodontal disease. Westcove believes that as the population continues to age, these percentages are likely to increase, prompting many to seek oral surgery procedures to pre-empt or treat many oral and craniofacial conditions.
Increasing Disposable Income:  According to the Organization for Economic Co-operation and Development (OECD) Better Life Index, the average household net adjusted disposable income per capita in the US is over $45,000 per year, almost 35% higher than any other OECD country in the world. Despite the effects of COVID-19, per capita disposable income in the US is expected to grow at an annualized growth rate of 1.2% through 2025. Increasing disposable income, combined with an aging population in need of continued oral health treatment has made the oral surgery sector a prime candidate for investment.
Private Equity Interest in Oral Surgery
Investment and Consolidation Rationale in Oral Surgery

Oral surgery has become an immensely attractive sector to private equity investors over the last three years and Westcove expects it to remain so for the foreseeable future. The oral surgery industry is enticing to private equity investors for numerous reasons, four of which are highlighted below.

Fragmentation
The oral surgery industry is highly fragmented as there are over 9,000 oral surgeons in the US, with the vast majority practicing in 1-2 surgeon practices. Like other physician specialty practices, oral surgeons and their practices tend to be localized, serving a relatively small patient and referral base. In more populous regions, numerous smaller (1-2 surgeon) and mid-size (3-4 surgeon) practices compete locally and regionally for patients and referral sources. In less populated regions, relatively few small practices (1-2 surgeons) compete on a hyper-localized basis for patients and referral sources. Thus, such extreme fragmentation is enticing to investors. By leveraging a “roll-up” strategy that bundles several practices together to create a cohesive organization that offers clinical excellence, the combined organization gains the scale to achieve operational efficiencies and the leverage to negotiate more favorable payor contracts.

High-Margin Procedures
Oral surgery procedures can range from tooth extractions to reconstructive jaw surgery. The spectrum of fees associated with the range of services provided by oral surgeons is expansive; tooth extractions can range in the hundreds of dollars, while extensive oral and jaw surgeries can cost in the tens of thousands of dollars. The blending of lower margin procedures with multiple high margin procedures produces a relatively high margin compared to other healthcare sectors, making it enticing to investors.

Highly Productive Practitioners
It is no surprise that since the cost of oral surgery procedures is relatively high, an individual oral surgeon or smaller group of oral surgeons (1-3 practitioners) can generate meaningful Adjusted EBITDA (earnings before interest, tax, depreciation and amortization, plus adjustments for personal, one-time, or other expenses paid for by the business). It is noteworthy that from 2011 to 2016, the average number of monthly oral and maxillofacial surgeries by practices increased from 24.92 to 29.25. While more recent data is not available, it is likely that this figure has increased or at least remained flat, coinciding with demographic and macroeconomic changes.

Essential Procedures
 Presently, the COVID-19 pandemic has challenged every aspect of society, and few industries, including healthcare, were immune from the negative economic effects of job layoffs, reduced consumer spending, and government shutdowns. Those services deemed “essential” by local and national governments avoided the worst of the pandemic and have provided investors with a new lens through which to gauge investment opportunities. Oral surgery, unlike general dentistry, was considered essential in many regions and was thus allowed to continue operating at a time when a myriad of other medical treatments, and elective surgeries were prohibited. Thus, private equity investors, as well as established dental organizations, are continuing to add oral surgery practices to their respective portfolios to expand their revenue mix and mitigate against potential future closures due to public health and economic crises.

Oral Surgery Consolidation History

National Oral Surgery Platform Transactions

As previously mentioned, consolidation within the oral surgery sector has followed a similar pattern to other physician specialty sectors: a first-mover makes an initial investment and rapidly expands across key geographies to establish regional and subsequently national coverage. Often, following the success of the initial platform, additional private equity firms enter the market to establish competing regional and national platforms. The following graphic illustrates the current platform investments, their private equity sponsors, respective geographies, and a brief timeline of the national and regional platforms created. In August 2018, RiverGlade Capital and The Thurston Group partnered with Austin Oral Surgery and Oral Surgical Associates of North Texas to create U.S. Oral Surgery Management, a national platform that has since expanded to multiple states. Over the course of 2019 and 2020, four additional national platforms were created: Paradigm Oral Surgery, Oral Surgery Partners, Allied OMS, and Beacon Oral Specialists
Highlights
In mid-2018, RiverGlade Capital and the Thurston Group made its first investment into oral surgery through a partnership with Austin Oral Surgery, and Oral Surgical Associates of North Texas to create U.S. Oral Surgery Management (USOSM). Since, USOSM has expanded into Colorado, Alabama, Georgia, Tennessee, Minnesota, and Oklahoma through regional partnerships and add-on acquisitions. In mid-2019, InTandem Capital Partners partnered with three practices in Nebraska to create Paradigm Oral Surgery. Additionally, Sheridan Capital Partners formed Oral Surgery Partners in Missouri and has since expanded into Illinois, Indiana, and South Carolina. In October of 2020, USOSM completed its first regional partnership in Oklahoma, partnering with a six-doctor practice, Oral and Maxillofacial Associates LLC. In December of 2020, Blue Sea Capital made a landmark investment in Atlanta Oral & Facial Surgery, and Bay Area Oral Surgery Management, creating a new national platform, Beacon Oral Specialists.
Founder Considerations
Considering a Transaction
Considering a transaction is an immensely personal decision. Shareholders must consider multiple economic and interpersonal factors when thinking through when and how best to pursue a transaction. A shareholder(s) might be interested in partnering with a financial sponsor to pursue growth, considering retirement in the relative near future, or want to mitigate the personal financial risk of having the vast majority of their wealth concentrated in their practice. Again, each shareholder’s decision is incredibly personal and is usually a combination of several factors. The advent of private equity investment into oral surgery represents an opportunity for shareholder(s) to seek access to growth capital and pursue personal financial risk mitigation for the first time. Unlike bank lending, private capital can be better tailored to meet the needs of the business, align incentives among new financial partners, and provide financial diversification previously unavailable to the shareholders of oral surgery practices. In a typical deal structure, private equity sponsors will make a control investment (greater than 50%) in a practice, and invite the shareholders to maintain a meaningful equity percentage (e.g. 20% – 30%, “rollover equity ”) in the newly created platform entity. The new entity’s debt facilities are guaranteed by the private equity platform and the shareholders no longer have personal financial liability for the practice. Other factors such as productivity, day-to-day management, and facilitating growth of the newly formed entity become the chief concerns of the shareholders and management team. As this entity grows, both organically, through add-on acquisitions, and increases profitability through the realization of operational and administrative efficiencies , shareholders participate in the growth through continued ownership in the platform entity. Shareholders will often participate in the substantial appreciation of equity value in the platform entity upon a secondary recapitalization, or “second bite of the apple,” after what is typically a five-to-seven-year period. In sum, shareholders can monetize the hard-earned value they have achieved over their careers, while reducing personal financial risk through asset (practice) diversification and pursuing broader growth strategies while meaningfully participating in the upside of such growth.
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