Executive Summary
Two weeks back, Patterson Companies, Inc. (NASDAQ: PDCO) sent out a signal to the markets about a potential buyout. Fast forward to DEC 12. 2024, PDCO announced that it has entered into a definitive agreement to be acquired by Patient Square Capital (Patient Square), a dedicated healthcare investment firm. The Leveraged Buyout deal has been valued at $4.1 B, representing an approximately 49% premium to the company’s enterprise value prior announcement.
The North American dental distribution space is highly competitive - consisting primarily of national, regional and local full-service distribution players. The distribution companies compete with each other, as well as several manufacturers, on the basis of price, breadth of portfolio, customer service and value-added products and services. In the U.S. and Canadian dental supply market, key players include Henry Schein, Inc., Patterson Dental, Benco Dental Supply Company, Burkhart Dental Supply and hundreds of distributors (and even manufacturers) that operate on a regional or local level, or online.
insightsZ Disclaimer: We acknowledge that our expertise and analysis do not extend to the animal health sector. Therefore, all views, commentary, research, and outlook presented in this document are based solely on areas within our domain of knowledge and intentionally exclude any consideration of the company’s exposure to the animal health industry. Any reference in this article should not be interpreted as an analysis, recommendation, or endorsement related to animal health, nor should it be considered part of our professional assessment of Patterson Companies, Inc. overall performance and prospects.
The New Reality
Dental companies are waiting longer to go public, and are focussed on prioritizing revenue-growth over other financial metrics, while remaining privately held. Similarly, the investor landscape for IPOs is evolving, representing a growing shift from predominantly large institutional investors to a broader base that includes retail investors, many of whom are increasingly influenced by social media rather than traditional investor roadshows. Meanwhile, the market for SPACs has cooled off after reaching an all-time peak during FY 2021.
During the times of economic uncertainty and equity market volatility, M&A deal activity declines as companies focus on their core business. Not just that, many businesses undergo cost reductions, portfolio restructuring and even divestitures – divesting underperforming businesses and assets. Despite this, high inflationary macro-environment, coupled with recessions (or periods shortly after recessions) and declining valuations is the perfect time for Take-private transactions – many of which are backed by LBO deals.
PE Groups are sitting on record-levels of available but uncommitted funds, also known as the ‘White Powder’. FY 2024 the combined value of announced Take-Private deals is estimated to be +DD% versus FY 2023 figures.
For public company boards looking to deliver shareholder value, Take-Private transactions provide premium valuations over the current market price to motivate current shareholders to sell. Maximizing value for existing shareholders means a share price at a trading premium at a time when the firm’s share price is likely under pressure.
In case of Patterson Companies’ deal, the company’s shareholders will receive $31.35 in cash per share, representing an approximately 49% premium to Patterson’s 30 calendar day volume-weighted average price (VWAP) ending December 4, 2024 (the last trading day prior to Patterson announcing the evaluation of strategic alternatives), or a transaction value of approximately $4.1 billion, including the refinancing of Patterson’s receivables facilities.
What made PDCO the ideal candidate for Take-Private Deal?
Declining Market Cap: 10. DEC 2024 Patterson’s share price was trading at $ 23,11. In more than 20 years of company’s history since it went public, the company has witnessed its stock price plummet this low only twice. Both instances coincided with significant macro events, including the COVID-19 pandemic hit in 2020 and the global financial crisis in 2008. Before the recent deal announcement, the company’s market cap had declined by 32% LTM alone.
Lower P/E Multiple: Patterson Companies, Inc. continued to demonstrate significant lower P/E multiple versus its peer group – an indicator of markets’ stumbling belief in the company’s expected future growth earnings as well as expected ROIC. insightsZ believes that the markets took the company’s recent performance as an anchor for projecting the company’s future growth, possibly even undershooting the PDCO’s long-term performance and driving P/E ratio below the company’s intrinsic value.
High Recurring CF: Being an aging company with high-debt capacity and strong cash-flows, PDCO meets the target criteria as a potential candidate for Take-private transaction. Like other mature companies, PDCO didn’t need access to large amounts of new capital to continue operating/ growth investments.
Negative Revenue Growth: PDCO’s dental BU demonstrated negative YoY growth in the recent 48 months – consistently underperforming the sector and missing its earnings guidance. During the above reported period, the company’s peer group incl. Henry Schein (NASDAQ: HSIC), Benco Dental, Burkhardt Dental among others performed significantly better than Patterson Dental BU.
How’s PDCO LBO expected to work?
The LBO deal (Leverage Buy-Out) will enable Patient Square Capital to acquire PDCO using a high level of debt to finance the transaction - effectively leveraging to maximize the ROE (return on equity) invested in the company’s operations. In other words, Patient Square Capital may finance only a small part of the purchase price with its own capital (equity).
Based on the size of AUM, Patient Square Capital is managing only USD 12 B as of September 30, 2024 – placing it as a large-size investment fund. insightsZ estimates Patient Square’s total equity investment in PDCO in the range of approx. USD 1.4 B, and assumes that the rest of the amount (representing approx. 66% of the deal value) is being financed as Private Debt – representing a major shift in PDCO’s capital structure.
The deal will be financed through a combination of committed equity financing provided by Patient Square Equity Partners, LP, and committed debt financing led by Citi, UBS Investment Bank, and Wells Fargo Bank.
The deal is expected to close in the fourth quarter of Patterson’s fiscal 2025, subject to the receipt of shareholder approval, regulatory approvals, and the satisfaction of other customary closing conditions.
Private equity firms and investment funds are the primary participants in LBO transactions. These funds raise capital from institutional investors (incl. pension funds or insurance companies) or even high-net-worth individuals to invest in private companies, typically with the goal of selling them after a few years. Their objective is to deliver substantial returns to investors, utilizing the leverage inherent in the LBO structure to maximize capital gains upon exit.
Post the successful deal completion, PDCO will become responsible for debt repayment, and the company’s EBITDA will be used to service the debt payments (incl. both interest and principal). LBO deals even take advantage of tax leverage by deducting the interest paid on debt to increase CF. Needless to say, Tax optimization is a critical component of how LBO deals are structured, especially concerning the deductibility of interest. For the same reason, any alterations in tax legislation can significantly impact the feasibility of the transaction.
insightsZ is not aware of the investment group’s design flexibility in terms of structure of equity investment/ plans to secure mix of senior-secure debt/ mezzanine debt etc. Neither its possible for us to assume any investment-specific protections that Patient Square Capital may place against future capital raises, future dilution, pricing drops, control and governance among others.
What’s the investment thesis of Patient Square Capital concerning this deal?
An LBO, by nature, is a financial structure aimed at maximizing profitability. insightsZ anticipates that Patient Square Capital will divest PDCO within a few years, typically between 5 - 7 years, at a significantly higher valuation, driven by enhanced financial performance and/or favourable market conditions - thereby achieving a substantial capital gain. However, this strategy obviously carries the risk of weakening the company by failing to turnaround, or even aggressively cutting operating costs to achieve profitability as quickly as possible.
The LBO deal offers PDCO the opportunity to step back from the harsh scrutiny of quarterly reporting, overhaul the company’s cost structure and try new business models.
Important: insightsZ is not aware of Patient Square Capital’s specific investment thesis or the strategies the investment fund intends to pursue in capturing value. However, one thing is clear: there is significant potential value to be realized in Patterson Dental, particularly if the company can be successfully turned around and repositioned as a Software-as-a-Service (SaaS) provider - focused on cloud and digital services. This could be achieved by drawing inspiration from the success of Henry Schein ONE. It is important to note that this perspective is speculative and should not be interpreted as an endorsement or representation of Patient Square Capital's actual plans or intentions.
SaaS covers Practice Management software, analytics, revenue cycle management, AI-based diagnostics, cloud-based services, patient engagement and patient education solutions. As Dental offices hyperfocus on streamlining operations, optimizing resources and obsess with patient care, SaaS enables them to deliver on all of the above areas while continuing to stay lean.
FY 2023 and FY 2024 Software as a Service (SaaS) was among the fastest-growing categories, significantly outperforming other high-margin, high-growth categories in dental incl. 3D printing, clear aligners and even intraoral scanners.
SaaS platforms have highly attractive unit economics and drive topline growth, coupled with better margins. Especially for bigger OEMs and distribution companies, any SaaS platform may gain leverage by accruing a greater number of active customers and installed equipment base at dental offices. Not just that, practice management and analytics focused SaaS aren’t just tools for office productivity improvements; instead, SaaS products are enablers for developing next-level ecosystems and generating network effects.
Henry Schein has a total revenue exposure of USD 8.3 B in in the dental category. insightsZ estimates that Henry Schein ONE, the SaaS arm of Henry Schein’s dental BU is valued anywhere between USD 3.6 – 4.2 Billon, based on a multiple range of 6-7X of Annual recurring revenue (ARR). This made the entity even pricier than many leading IOS technology or clear aligner brands. That’s despite Henry Schein ONE’s revenue is hardly expected to exceed USD 650 million in FY 2024 (Henry Schein ONE™ valuation estimates represent anywhere between 38-44% of Henry Schein’s entire market capitalization as of DEC 13. 2024).
Henry Schein’s Dentrix™ and Dentrix Ascent™ have captured 37% and 5% of the US Dental services market respectively. Dentally™ Cloud revenue increased by 36% LTM, outperforming the category. Other brands incl. Dentrix Ascend™, VideaHealth™, and Jarvis™ Analytics platforms also continue to demonstrate strong growth.
Henry Schein didn’t get to where it is today alone. After succeeding in acquiring a lion’s share of the North American dental distribution market, the company underwent an acquisition spree in the last 5 years – propelling a legacy distribution business to become one of the most valued tech companies in the dental space. In other words, Henry Schein ONE™ enabled the legacy distribution-focused company to grow new tentacles, snapping up companies in data analytics and practice management category to add further revenue streams and outperform its competition. This is in stark contrast to other distribution companies that have never viewed software and UX as a driver for growth. What’s worse is that other North American distribution companies neglected to build their internal capacity for innovation in PMS category, with little or no focus on M&A.
What’s even more important is that Henry Schein exhibits no signals of slowing down, with additional acquisitions planned in its M&A pipeline to further strengthen its SaaS capabilities – bolstering the company’s top line growth, even as the company’s legacy dental equipment and consumables distribution business slows down.
Over the years, Henry Schein has succeeded in capturing a greater share of the market than its biggest rivals including Patterson Dental and Benco Dental. Not just that, the company’s markups — a measure of companies’ profits and market power — have increased more than its competition.
Patterson’s Dental BU needs to transformed into a SaaS + Cloud-heavy BU
Patterson Dental’s market share in the North American Practice management software hardly exceeds 15%, and has continued to remain somewhat flattish in recent years, whereas Henry Schein ONE™ has grown +DD on YoY basis (with the exception of FY 2024, where HS ONE™ grew +HSD). This is a good example of the run-away available for Patterson Dental to capture additional market share in the category.
In recent years, Patterson Dental has already started its multi-year transformation in terms of increasing the company’s revenue exposure to SaaS and e-Services category by announcing its strategic partnership with leading AI provider Pearl® in Q4’23. The company’s AI-based pathology diagnostics software Second Opinion® is now integrated into Patterson Dental’s practice management software Eaglesoft®. Additionally, PDCO- Pearl® collaboration aims to distribute Pearl's cutting-edge Second Opinion® and Practice Intelligence® software solutions via Pattersons’s salesforce. Earlier this year, Second Opinion® announced integration with Patterson’s Dolphin practice management software.
Servitization of the Industry is an ongoing Trend
The Global dental manufacturing and distribution industry is undergoing a tectonic shift as companies are reshaping their business strategy from legacy distribution and after-sales business to a new model that’s focussed on digital services & integrated solutions. Earlier this year, insightsZ predicted leading global IOS brands to generate >40% of their customer LTV revenues, and up to 70% of their LTV profits with digital services by FY 2025.
Servitization is a new strategy that leading dental manufacturer and even distribution heavyweights are leveraging to differentiate their strength as they try to re-integrate their offerings better into the dental services value chain. Servitization enables equipment being bundled with digital services, including cloud-based enterprise software, which enables manufacturers and even distribution companies to make software updates to their equipment in days or weeks – dramatically reducing software release cycles.
This Servitization shift is enabling OEMs and distributors alike to fulfil underserved customer needs, and focus more on delivering digital services. This transformation from selling equipment + SW to selling outcomes is a combination of several factors: continuous innovation in the industry, commoditization of equipment, slower than expected growth gradually hurting margins and customer loyalty, and a strong customer’s willingness to shift from upfront large capital expenditure (CAPEX) models to recurring, predictable operating expenditure (OPEX) models.
Especially high value customers incl. DSOs are increasingly expecting business outcomes from their equipment manufacturers and suppliers – and outcome-based services are the new megatrend. In particular, DSO contracts are much broader in scope, and may cover all the equipment at a given location, multi-offices or even an entire fleet of equipment operated at DSO offices. This allows DSOs and OEMs to collaborate better and analyze data from their installed base and use the information to design + build better customized, digital services.
insightsZ believes that emerging categories incl. 3D Printing & AM are not immune to servitization either, as concerned OEMs and sellers may soon start packaging predictive maintenance, performance improvement and other digital services with hardware and equipment sales.
Of course, new commercial models come with new pitfalls and challenges. As manufacturers move away from traditional sales models or more simply ‘one-time sales of equipment’ to newer pricing models, the company’s salesforce as well as its reseller network may act as resistance – making new sales even tougher. Not just that, it’s equally hard, if not more difficult, to market the new commercial model to existing customers as they may have to pay for a separate cloud, SaaS or other digital services subscription. This is especially difficult if they have been receiving some nonautomated version of the service and CAD/CAM software FOC or at lower prices. Likewise, the company’s sales reps may be tempted to give away the digital services as a ‘freebie’ to discount the equipment cost, to help make the larger ticket sale.
OEMs are considering strategies to avoid the bundling discount trap by hiring + re-training new salesforce, embedding the charge in a higher equipment price, or considering a tiered model in which basic services are given away, but customers are upsold later once they realize the value. A great example of this is online cloud or software subscriptions that are given away FOC (free-of-cost) for a limited 3-6 months window period.
Leading OEMs and even major distribution giants are ramping up their R&D investments in digital technologies, and accelerating their rollout of digital services. Many players are even snapping up software companies to improve their digital offerings. For example, North American distribution giant Henry Schein went on an acquisition spree in the last 5 years – propelling a legacy distribution business to become one of the most valued tech companies in the dental space. Henry Schein ONE™ enabled the legacy distribution-focused company to grow new tentacles, snapping up companies in data analytics and practice management category to add further revenue streams and outperform its competition.
The share of DSOs in the North American dental services space continues to increase on YoY basis, and so do concerns around information security and patient privacy. As DSOs continue to drive standardization, cost & resources management and optimize reimbursement rates, centralize procurement and get scale on purchasing, cloud-based solutions can be a key differentiator. It is no secret that DSOs, just like dental offices, do not want to manage complex tech infrastructure and software stack.
What’s even more important is that Henry Schein exhibits no signals of slowing down, with additional acquisitions planned in its M&A pipeline to further strengthen its SaaS capabilities – bolstering the company’s top line growth, even as the company’s legacy dental equipment and consumables distribution business slows down.
How is Patterson Dental’s Peer Group performing in SaaS and Cloud-based services category?
Benco Dental
The rules of the game have changed and the playbook has evolved. Despite this, Patterson Dental was finding it extremely difficult to adjust itself to the new normal. That is, Patterson Dental is still focussed on its legacy sales and service business – an indication of company’s short-term thinking and overemphasis on margins, which compromised the company’s valuations and its ability to deliver long-term returns.
Unlike Henry Schein’s dental BU (#1 rank market-share), which effectively succeeded in rebranding itself and thrive as a SaaS business, Patterson Dental even lagged behind its rival Benco Dental (#3 rank market-share), which demonstrated strong growth not only in terms of share-of-wallet of enterprise DSO clients and multi-office providers, but also in revenue growth% YoY.
FY 2023 Benco Dental sold 26% more scanners versus during FY 2022. During the same reporting period, the company witnessed 71% higher 3D Printing equipment sales.
OCT 2023 Benco Dental acquired PPO Profits, a leading providers of dental fee negotiations and revenue cycle management services – to increase its revenue exposure to digital services.
AUG 2024 Benco Dental continued its acquisition spree – adding M&S Dental Supply and A-Dent Dental Equipment under its umbrella brand, and succeeded increasing its market-share in the country’s equipment sales, service and office design category.
Henry Schein (with focus on HS ONE™ Portfolio)
Henry Schein offers >300,000 products worldwide, with up to 70 percent of the company’s revenue coming from North America alone. Traditionally, a relatively low-margin distribution business, Henry Schein is now reinventing itself and turbocharging its growth with Henry Schein One™. With +8,000 salesforce size, the firm can directly reach the offices of dental practitioners across the US and beyond.
As one may expect, margins are the name of the game in the distribution business, and any efficiency gains have an outsized impact on the business. The company’s operating margins as well as other metrics continue to set the benchmark in the distribution category. That being said, Henry Schein has traditionally still been just a distributor… however, that’s changing now!
Unlike major DSOs that enter into year-long partnerships with distribution companies and have higher switching costs (incl. but not limited to long-term contracts for updates/upgrades and maintenance), many small & medium-sized dental offices frequently engage in price shopping – especially concerning high value items purchases.
In recent years, efficiency in dental services category has grown dramatically as dental offices became more productive – translating into lower treatment services pricing and faster practice growth. In US alone, up to 99 percent of the country’s dental offices are already using Practice Management SW, enabling practice owners to benchmark their practice metrics versus other dental offices and even DSOs – both regionally as well as nationally. Unlike high-cost CapEx associated with equipment purchases, most SaaS services incl. PMS easily fit within dental office’s operating budgets. As a matter of fact, a bigger expense for dental offices is the cost of the staff spending time with the software service & related tasks - a cost that’s often many times greater than purchase price.
With a market penetration of 99% in US and Canada, as practice management software reach initial S-curve, revenue growth is expected to slow down a bit until companies continue to add new features/functionalities and enter new markets outside North America. LTM Patient Marketing SaaS enabling campaign performance management, claims and reimbursements - are witnessing outstanding adoption-rates. The classic discussion about whether investment in practice digitization is an expense or investment for future growth continues as many more AI players enter the SaaS race. In the meantime, HS’s leading Dentrix Enterprise continues to outsell Dentrix by 3:1 in the DSO Space, based on company sources.
Not all cloud providers are the same! A simplified cloud-based hosting of a legacy operation is not to be considered a cloud-based application since it does not use cloud’s native technology, and neither it supports the indefinite growth potential of the cloud.
Henry Schein has acquired a number of software companies in the last 60 months, and merged all software + analytics brands under Henry Schein One™ umbrella. The North American distribution company is trying to be the largest dental software company in the world as it actively manages >70 software applications globally, together with its team of customer success managers, who are key to the HS One’s growth. The company’s portfolio of PMS (Practice Management Software) has more than 75,000 active customers in North American alone, and an additional 25,000 customers outside North America. Not just that, the company’s PMS Dentrix™ is the #1 player in US DSO & small/medium dental office category.
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