Private Equity, CSOs and Capitalization

by Timothy A. Brown FRI, CEO & Broker of Record - ROI Corporation

The renowned Warren Buffett has a very simple indicator of whether stocks are under or over valued. He takes the entire US stock market capitalization (the collective value of every stock traded) and then divides the number into the gross domestic product of all U.S. companies. Basically, value divided by revenue.

If we were to apply the same principle to the Canadian dental marketplace we could come up with a similar indicator. In year 2020, the entire Canadian dental industry will generate about $20 billion in total revenue.

Based on recent rumoured sale prices, particularly those that are being paid and offered by some of the private equity accumulators, also known as the corporate service organizations (CSOs), it is suggested that they are paying up to 200 per cent or two times annual revenue.

That would suggest a total market capitalization of all Canadian dental practices is $40 billion. This suggests 200 per cent market capitalization. Historically, this has never happened.

Logically, it seems absurd. Normal repayment rates and amortizations fluctuate around the 10-year mark. 100% market capitalization can be repaid with ease in 10 years or less.  At the 200 per cent market capitalization level, and using typical overheads of 60%, a 20-year amortization is required to repay the investor/bank/private equity. I do not know of a Canadian bank (some of the most respected on the globe) that would give a purchaser a 20-year amortization to repay a dental practice acquisition loan.

When I started working for my father in the in the late 1970’s, amortizations were 5 years. 30 years later (after a very long process) our firm pioneered and subsequently persuaded banks to go up to 10-year amortizations. Now some banks are offering 12-year amortizations. But I do not foresee any bank going up to 20-year amortizations any time soon.

If private equity is patient enough to wait 20 years for a repayment, that is their decision. There must be some other rationale as to why they are investing in CSOs?

I remind the reader that CSOs add expenses to dental practice, they do not reduce overhead. They have management teams and also a hefty dividend and/or premium that must be paid to private equity. Canadian banks are presently lending money to traditional dental purchasers at prime rate, which is 3.45 per cent. I would be shocked to discover that any private equity fund would invest in a dental practice or corporate service organizations for a 3.85 per cent return on investment. Just something to think about.

About the Author

Timothy A. Brown has risen to national prominence as CEO and Broker of Record of ROI Corporation, Canada’s #1 professional practice appraiser and broker. His insights, research and experience has made him a highly sought after professional speaker and a respected author and publisher. As a leading national authority in understanding and identifying the potential of today’s market, Timothy has customized presentations that illuminate themes and trends that are of interest to business owners at all stages of their careers.

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