This article was written by Michael W. Davis, DDS and published on LinkedIn, as well as other reputable websites. The Hindley Burgmaier Group is proud to share this article with you.
Implications of Dental Support Organizations’ Real Estate Sell-Off
By: Michael W. Davis, DDS*
(Contact: MWDavisDDS@Comcast.net)
In recent months, larger dental support organizations (DSOs) have been either selling off their real estate assets, or current property ownership is attempting divestiture of such properties. These transactions are frequently with real estate investment trusts (REITS). Once the purchase agreement is completed, the REIT may then lease back the property to the DSO with a long-term lease beneficial to both parties. Or the REIT or new property owner may assume an existing lease as landlord.
A REIT is a publicly traded company that owns, operates, or finances income-producing properties. An individual REIT may own a collection of properties ranging from shopping malls to movie theaters, apartment buildings to office parks, industrial parks to hospitals. A REIT may specialize in a certain real estate sector, or it may diversify into a variety of property types.
Aspen Dental
Aspen Dental Management, Inc (ADMI), as part of The Aspen Group (TAG)1 is privately equity owned and majority-owned by Ares Management, LP and Leonard Green & Partners, L.P. 2 The remaining 20% is owned by American Securities, management, and individual dentists.
Aspen Dental currently represents the second largest chain of corporate dental clinics in the USA. The company reports they service more than 1000 Aspen Dental-branded practices in the nation.3 Their optimistic projected expansion target is to open 75-100 clinics every year. Aspen Dental’s target demographic is middle income, blue collar, and seniors. They are seeking new site locations for their anticipated expansion in major retail areas.
Through the years, Aspen Dental has suffered what some might politely term “growing pains.” For a variety of alleged statute violations, Aspen Dental has settled with the state attorneys general in Pennsylvania,4 New York 5 , Indiana 6 , and twice in Massachusetts 7,8 .
On March 15, 2024, a class action lawsuit was filed against TAG, and affiliated companies ADMI and WellNOW Urgent Care, PC in US District Court for the Northern District of Illinois.9 Plaintiffs allege defendants’ failed “to implement reasonable and industry standard data security practices to properly secure, safeguard, and adequately destroy Plaintiff’s and Class Members’ sensitive personal identifiable information that it had acquired and stored for its business purposes.”
It was further alleged in the complaint, “Defendants disregarded the rights of Plaintiff and Class Members (defined below) by, inter alia, intentionally, willfully, recklessly, and/or negligently failing to take adequate and reasonable measures to ensure its data systems were protected against unauthorized intrusions; failing to disclose that it did not have adequately robust computer systems and security practices to safeguard Plaintiff’s and Class Members’ Private Information; failing to take standard and reasonably available steps to prevent the Data Breach; and failing to provide Plaintiff(s) and Class Members with prompt and full notice of the Data Breach.”
Also in 2024, Aspen Dental settled a class action lawsuit in Florida related to alleged violations to the Florida Telephone Solicitation Act.10 An apparent conflict arose between company marketing strategies and patient rights of confidentiality.
To acquire its place at number two in the numbers of USA dental clinics, Aspen Dental has relied upon borrowed moneys from the subprime (junk) bond market for company expansion. Prior to current economic inflation and pre-pandemic, money was historically very inexpensive to borrow. Since that time, lenders now demand a higher interest rate. Many today will also only accept first-lien bond products.
The Financial Times published an interesting story on July 23, 2023.11 They reported the risky US bond market was hit with the largest wave of ratings downgrades, since the depth of the COVID pandemic in 2020. ADMI’s bond downgrade was one company among several cited in this report.
A couple of months later on September 11, 2023, S&P Global revised ADMI’s bond outlook from stable to negative. The report highlighted ADMI’s lagging financial and operating results due to the 2023 cyberattack and weak performance of WellNow urgent care and ClearChoice dental implant businesses.
ADMI troublingly faces the maturities of its first-lien term loan ($875 million outstanding) and $450 million revolving credit facility ($272 million outstanding), which come due in 2025. The analysis reported ADMI held good prospects to improve performance over the next year (2024) given favorable growth trends in its dental business (Aspen Dental), and the one-time nature of the cyber incident. Unfortunately, S&P Global believes there is heightened refinancing risk based on its weak free cash flow generation, high leverage, and challenging capital market conditions.
Centered on this negative outlook, S&P Global revised their forecast on Aspen bonds from stable to negative, which included a B- credit rating. A further warning was issued that if ADMI could not materially improve operating performance over the next several quarters, near-term debt refinancing ($450 Mil due in 2025) would be challenging. This raised the specter of a potential bond default. Adding fuel to the fire, the Federal Reserve is unlikely to lower interest rates in this current climate of suborn inflation.
A revised report in December 2023 elevated the ADMI bond forecast from negative to stable, although the B- rating remained unchanged.
Fidelity provides a good general overview on how bond ratings work from the stronger investment grade to more speculative non-investment grade (also termed high-yield or “junk bonds”).12 This is critical information not only for bond investors, but those who may acquire an equity stake in companies leveraged in various bond markets.
Subprime bond investors (some might argue “speculators”) have a variety of resources to do their due diligence prior to risking money. Dental consumers (patients), vendors, employees, and potential employees might also be wise to access such information. Much may be retrieved in the public domain. Other details (especially with privately held companies, including almost all DSOs) are often limited to purchase of an investment service from a company such S&P Global13, Moody’s Analytics14 , CoreLogic15 , Dun & Bradstreet 16 , etc.
Such information should be of critical importance to anyone, and in particular doctors, who may be proffered equity stock in DSOs.
Regardless, if information is sought by an investor, the media, or anyone in the public, privately held companies (as is most of the case in the DSO industry) are not usually subject to US Security and Exchange (SEC) rules. Transparency, disclosures, and avenues for redress are more limited. Accounting books are generally only subject to full review by the parent company and the IRS. Others can pound sand, except possibly, in the event of a legal action and hard-fought disclosures in discovery.
Various Aspen Dental properties are on the market and advertised through companies like Net Lease Advisor.17 In recent months, ADMI (TAG) properties have been divested to major REITs like Four Corners Property Trust (FCTP).18,19
Triple Net Investment Group also markets ADMI properties.20 These arrangements are for current property owners with a current net/net/net lease with ADMI, to new potential private owners. Some property investors may not be fully comfortable securing properties whose tenants have long-term leases and are very highly-leveraged in the subprime bond markets.
Commercial Real Estate Exchange, Inc. (CREXI) lists numbers of ADMI properties from Crossville, TN, Perrysville, OH, New Castle, PA, Fayetteville, GA, Plano, TX, McKenney, TX, Battle Creek, MI, Algonquin, IL, Westminster, CO, Montgomery, AL, York, PA, Lafayette, LA, Mount Pleasant, MI, Stockton, CA, Charlotte, NC, etc.21
Ownership is not disclosed in the listings, be it TAG, an unaffiliated private company, a REIT, or a joint venture. Again, and this cannot be emphasized enough, potential property owners may or may not be comfortable holding long-term leased property to any tenant with highly-leveraged non-investment grade debt loans. Regardless, the sheer volume of listings gives weight to the growth of Aspen Dental.
Heartland Dental
Heartland Dental operates the nation’s largest DSO, with more than 1700 offices across 38 states and the District of Columbia.22 Unlike Aspen Dental, Heartland practices are generally not branded. The public normally does not know which practices are affiliated with Heartland Dental in a branding strategy termed “stealth branding.”23 Office signage, logos on stationery, advertising, etc. infrequently reflect the Heartland Dental brand.
One risk run by the transparent branding of DSOs, in contrast to Heartland Dental, is a plethora of negative patient comments on social media. These may be found on easily accessed websites such as “Stop Aspen Dental Group”24 , Yelp25 , and Pissed Consumer.26 Stealth branding by Heartland Dental largely sidesteps this matter.
However, ADMI counters the adverse patient and employee commentary on social media with some of the finest external marketing in the dental industry. Their television ads include outstanding eye-appealing layout, engaging storytelling, targeted fine-tuned psychographics, and driving emotional appeal.27 No doubt, such an advertising budget does not come inexpensively.
Heartland Dental is majority owned by the global investment firm of KKR & Co.28 Minority ownership is held by the Ontario Teachers’ Union, founder Dr. Rick Workman, CEO, and President Pat Bauer, as well as some dentists and employees.
Like Aspen Dental, Heartland has experienced and is driving very rapid growth. However, their business models, strategies, and target demographics differ from ADMI.29
Heartland’s Executive VP and Chief Growth Officer, Mark Greenstein commented on what his DSO sought in acquisition of a dental practice for affiliation, “We prefer an office to have five or more dental chairs, with clean and well-maintained equipment, housed in a highly visible and easily accessible location. We usually find this combination in suburban areas with a stable or growing population and a broad base of insured and cash-paying potential patients interested in lifetime oral health care.”30
One can understand the target patient demographic may differ between Heartland and Aspen, and any other DSO. In fact, within any given DSO there may be a variety of differing practice models and clinic types.
From a Heartland press release: “In 2023, Heartland Dental constructed and received certificates of occupancy on a record-breaking 94 state-of-the-art dental practices comprising new supported offices in high-growth markets across the country and expanded relocations of existing offices to support their further growth.”31
S&P Global generated a bond rating’s report on Heartland Dental on April 27, 2023. Similar to ADMI, Heartland carries very substantial non-investment grade debt, and a stable “B-“ bond rating.
In the bond default simulation played out by S&P Global, Heartland generated a recovery rating of ‘3’ (50%-70%; rounded estimate: 50%) recovery, in the event of a payment default on their first-lien secured debt. However, on senior unsecured debt, recovery was estimated at 0%.
On March 26, 2024, FCPT announced the acquisition of Heartland Dental property in Alabama.32 Earlier on March 2, 2023, an announcement was made by FCTP of a property purchase from Heartland Dental for $2.2 Mil.33 FCPT also recently announced purchase of a Heartland Dental property in Kansas for $3 Mil.34 A Goodyear, AZ property, with Heartland Dental as a tenant, sold on September 26, 2023.35 In Meridian (metro-Boise), ID, the sale of a Heartland Dental building owned by Northwest Development Group (corporation now dissolved in ID)36 was sold to a private buyer.37 Clearly, many or most of the Heartland Dental real estate sales are by entities not necessarily affiliated to Heartland Dental.
CRXI also lists numbers of Heartland Dental properties for sale. These include clinics in Covington GA, Holly Springs, NC, Bonaire, GA, Saint Johns, FL, Charlotte, NC, Moncks Corner, SC, Madison, AL, Southern Pines, NC, Springdale, AR, Salem, VA, Bluffton, SC, Severna Park, MD, Naples, FL, Charlottesville, VA, etc.38 Only a very few display Heartland Dental signage which is consistent with a stealth branding strategy.
Implications to DSOs
Construction build-outs on de novo startup dental facilities are expensive. Leasehold improvements, especially for the unique requirements of dental clinics, can also be quite costly. Large DSOs are obviously spending many millions of dollars, especially with leveraged (borrowed) money. Unfortunately, bonds issued by the DSO industry generally fall significantly short in rating, compared to investment grade securities. Such loans are costly to service.
Bond money raised today comes with higher interest rates, compared to only a few years ago. The default risk is also higher currently, which in turn means borrowers can demand even more favorable terms squeezing corporate borrowers. Operational cash flow is often decreased by our higher interest rates and default risk.
DSOs potentially selling off real estate, especially projects co-financed by the DSO and a development company, places money immediately back onto the DSO’s balance sheet. Regardless of the buyer (private concern or a REIT), cash flow is essential to service a DSO’s debt. Such cash may also be leveraged to borrow additional sums and further company expansion. Some degree of “cash on the books” may also make a DSO more attractive, in a possible roll-over buyout by another private equity company.
Implications to the Public
DSOs and their private equity parent companies are either the beneficial owners of their “supported” dental practices or largely control these clinics. Businesspeople investing many millions of dollars reasonably expect a decent return on investment (ROI), especially with higher risk operations.
Contracts between DSOs and “owner” doctors (often held as a professional corporation- PC) are nearly always one-sided favoring the DSO. Agreements such as management service agreements (MSAs), business service agreements (BSAs), and administrative service agreements (ASAs) generally will have the DSO control the clinic’s (nominee owner’s) bank account. DSOs will also usually control which insurance plans they participate in, supplies and equipment purchased, specialists selected for patients, limitations of dental labs used, hours of operation, marketing scheme, and employment of alleged non-clinical staff (responsible for patient scheduling) and often clinical staff as well.
Contract wording to the effect, that the DSO and owner dentist are independent contractors of the other is almost always a misrepresentation. The DSO is clearly in the driver’s seat for control and operation of the dental facility. Actual dentist ownership is nearly always a distorted talking point. Otherwise, no private equity firm would risk their investors’ money.
That must be expected. Private and public companies have a fiduciary obligation to generate maximal ROI for their investors. DSOs and private equity firms must serve the interests of their shareholders, above all others.
By contrast, doctors have an ethical and legal obligation to place the interests of their patients foremost. The conflict of interest with non-doctor beneficially-owned and controlled dental practices is obvious.
Patients are almost always ignorant that an unmentioned third party has violated their doctor/patient relationship (contract), as well as corrupted the informed consent process. Unfortunately, regulatory enforcement is grossly remiss. The question arises; Why is the private equity industry in the practice of healthcare?
Of recent interest was the bankruptcy of Benevis in 2020.39 Best known for operating a vast number of children’s Medicaid-focused clinics under the Kool Smiles brand nationally, Benevis also ran general dentistry and specialty care, including orthodontics and oral surgery.
Through the bankruptcy court, New Mountain Capital acquired ownership of Benevis. New Mountain Capital also owns Western Dental and its affiliates like Brident. Today, New Mountain Capital is the largest provider of children’s dental Medicaid services. A single private equity firm sits in the catbird’s seat in negotiating and lobbying with state and federal governments related to providing children’s dental Medicaid services.
Implications to Doctors
Doctors selling their dental practices to DSOs may accept a promise, that after “x” number of years, the DSO will fulfill a backend payment to the doctor. This period may be from 3-5 years and includes the doctor remaining at the practice and specific production quotas are met.
Previously, doctors often received 80%, with a cash up-front and cash deferred basis. The remaining 20% was in equity shares of either the existing dental practice or the DSO.
Today, in our tighter economic situation, we commonly see only 50% of the offered selling price provided on some sort of cash basis, up-front or deferred. The remaining 50% is remunerated with stock equity shares.
Unfortunately, the DSO may dramatically change the culture of the practice. Decisions the owner/dentist formerly made may subsequently be assumed by the DSO. Time allotted per patient may be controlled by the DSO. The doctor may lose control over staffing, laboratory selection, and dental supplies, all potentially affecting patient welfare.
Selling doctors are usually required to maintain a set level of clinical dollar production, or face penalties. This may result in total loss of the “guaranteed” backend payment, or even the doctor’s employment being terminated.
Many DSOs also take a management fee of 5-15% out of total collections. This may be viewed as unlawful fee-splitting, with an unlicensed entity owning a dental practice. However, as stated earlier in this report, regulatory enforcement is disturbingly remiss.
Sometimes, the selling doctor or even associate dentists will be offered equity shares in the DSO or the dental practice. Too frequently, the DSO may employ strong arm tactics to motivate doctors to purchase stock shares. The DSO may also completely deny redemption of shares, or only do so at a steep discount.
While such activities may serve the DSO’s balance sheet, dentists may be left with a sizable percentage of their retirement savings locked up as a minority shareholder in private stock equity. Such investment products enjoy little to no oversight by the US SEC. Majority (not minority) owners determine private stock valuations, conditions of trades, timing of trades, and disclosures.
In the unfortunate event of a DSO bankruptcy, first-lien creditors will be first in line for payouts, followed by second-lien borrowers, and down the line. Last to be paid will be stock equity shareholders.40 Numbers of individual dentists took a big hit in the aforementioned bankruptcy of Benevis.
Privately controlled companies, lacking US SEC rules and direction have too often entered into alleged stock dilution schemes. Majority owners generally control additional sales of equity shares to their advantage, and the possible disadvantage of minority owners. In one case, minority owner dentists selling their practices to North American Dental Group for shares in Zahn alleged their stock was unfairly diluted and they suffered loss in retirement savings.41,42
Interestingly, alleged unlawful stock dilution was at the core of a lawsuit between two larger DSOs, Mortenson Family Dental vs. Heartland Dental Care.43 It is not just the little guy who may be a target for alleged illegal stock dilution.
Another possible problem among many is the potential closing & downsizing of less productive clinics by the DSO. Employees, be they auxiliaries or doctors, will have zero say in such business decisions. Patients may apparently be abandoned. Workers may be left unemployed.
Doctors must realize, sometimes after multiple stressful encounters, that what they formerly may assume to be “their” dental practice is in reality controlled by a DSO. Almost never will an affiliation contract between an “owner” dentist and the DSO support-vendor, allow the doctor to fire the DSO and seek services elsewhere in any real terms.
Conclusion
Debt and equity go hand-in-hand in modern large scale investing.44 DSOs desiring buyouts and de novo startups while sitting on cash, utilize leverage to maximize deals. In essence, buyouts are orchestrated for leverage between the buyer, and most critically, bond and equity investors. Risks are seemingly often stretched to the point of loss of stomach lining. All the while, many are totally ignorant of their degree of risk, or feign ignorance.
As British economist John Kay elucidated in his classic, “Other People’s Money,” short-term gains cannot continually assume priority over long-term company value creation. The world of finance has disconnected from the interests of clients, as well as the overall public interest.
Paget, Walde and Verbov raised interesting issues in their exploration of private equity’s evolution since the 1980s.45 KKR’s (parent company of today’s Heartland Dental) highly leverage buyout of Nabisco triggered a chain reaction in the world of investment banking. Today, private equity investing is a strong major asset class.
Dental healthcare has traditionally been considered a fragmented cottage industry with no clear leader. No one practice had enough market share to influence prices, production, investment, and competition. Doctors were most inclined to focus on their patients’ interests, versus generation of ROI for the investor class.
Private equity through the DSO industry is consolidating the dental marketplace. Doctors are largely becoming employees ultimately answering not to patients’ welfare, but to unlicensed investors and their subordinate managers.
Favorable patient outcomes can and do occur regardless of the clinical setting. However, when clinicians answer primarily to the investor class and their surrogates, outcomes may darken.
DSO real estate purchase and sales should not be viewed in isolation. Such activities represent implications within a much larger scheme. Such signals play into our current financial climate of inflation and higher interest rates which negatively impact the dental healthcare industry.
Bond defaults, corporate refinancing at unfavorable terms for borrowers, and bankruptcies will negatively impact majority ownership at DSOs. However, the fallout will also extend to dental professionals and the public. There exist numbers of safeguard benefits to a fragmented dental industry, which operates outside the confines of the private equity industry.
*(Disclosure- the author owns a mutual fund of REITS which appraises at less than 1% of his retirement assets.)
References (accessed April 28, 2024)
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21. https://www.crexi.com/properties/tenants/Aspen_Dental
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29.https://blog.heartland.com/heartland-dental-celebrates-record-new-construction-affiliation-growth-and-technology-enhancements-in-2023
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34. https://www.reitnotes.com/reit-press-releases/FCPT-Announces-Acquisition-of-a-Heartland-Dental-Property-for-3-0-Million
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40. https://www.investopedia.com/ask/answers/09/corporate-liquidation-unpaid-taxes-wages.asp
41. https://www.linkedin.com/pulse/100-dentists-suing-dso-yours-next-dr-bryan-laskin/
42. https://www.groupdentistrynow.com/dso-group-blog/dentists-file-legal-action-against-dso/
43. https://casetext.com/case/mortenson-family-dental-ctr-inc-v-heartland-dental-care
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