Out-Law Analysis | 05 Jun 2020 | 1:56 pm | 12 min. read
Dental law specialist Paul Krivosic of Pinsent Masons, the law firm behind Out-Law, has teamed up with industry experts to explore the challenges facing dentists in re-opening, how the coronavirus crisis is likely to impact mergers and acquisitions in the sector, and how technology offers operators an opportunity to raise new revenues at a time when many practices face going out of business without fresh financial support.
All routine dental care has been on-hold since the NHS issued their preparedness letter dated 25 March 2020. Since then, the only services offered by practices, rather than newly established urgent dental care centres, is telephone triage, which can offer treatment by way of the three ‘A’s – advice, analgesia and antimicrobial means.
The NHS subsequently updated its guidance on 28 May 2020, stating that all NHS dental practices should re-open from Monday 8 June 2020 so long as they can comply with infection control procedures and meet personal protection equipment (PPE) requirements. As the availability of PPE and the interpretation of the new operating procedures will vary from business to business, it is unlikely all dental businesses will be able to re-open on 8 June.
Former CEO, The Houston Dental Group
There is a real possibility that the costs involved in making a premises suitable for patients under the new protocols will be untenable for some practices and physically impractical for others
In any event a business seeking to re-open would have to be sure that their indemnity cover covered the treatment they were giving, and that their patients are safe. Failure to do so could lead to action by the General Dental Council. We also expect the Care Quality Commission to play an active role in ensuring infection control procedures and PPE requirements are being complied with.
Private dental businesses are also encouraged by the NHS to re-open on 8 June 2020. However, compared to their NHS counterparts, they have received very little guidance to help them do so. Both the Care Quality Commission and General Dental Council have issued statements, re-iterated by the British Dental Association (BDA), confirming that the decision to re-open a dental business is one that rests with the dental provider.
Each provider will have to make their own decisions on the extent of services they feel comfortable offering at the initial stage, and there remains uncertainty over whether patients will feel safe to visit.
David Houston, former chief executive of The Houston Dental Group, said: "There is a real possibility that the costs involved in making a premises suitable for patients under the new protocols will be untenable for some practices and physically impractical for others given the limitations of their premises."
Both NHS and private dental care providers face a challenge in how they give comfort to patients that their health is not at risk by taking a trip to the dentist. If patients refuse to attend for routine check-ups this could have a bearing on potential clawback of NHS funding.
NHS businesses will soon have to agree their 2019/20 units of dental activity (UDA) performance figures with local commissioners. In place of the March 2020 figure, businesses can ask commissioners to use the March 2019 figure or an average taken from three months of the 2019/20 year. Clawback will operate in the same way as it has done in prior years, although payments will be spread over the year.
It is not clear whether breach notices will be issued for dental businesses whose performance in 2019/20, as agreed using the principles above, does not meet the 96% UDA delivery target.
Under the temporary financial arrangements, the NHS is continuing to pay contract payments at 2019/20 levels during the 2020/21 financial year, despite the fact no routine dentistry is being performed under the contracts. Despite dental businesses being allowed to re-open from 8 June 2020, the NHS has said that the temporary financial arrangements will initially continue in an apparent recognition that this will not be a fast re-start for dentists and patients alike. At the very least, when the temporary measures do come to an end, it is to be hoped that dental businesses will have been given sufficient notice of any withdrawal of funding.
Businesses have a choice either to reduce the monies paid to their associates with a view to topping it up later, or pay the normal UDA rate and then seek to reclaim monies from the associates later. The former approach arguably does not honour the NHS's requirement that associates be paid 'at previous levels', whereas the latter approach carries commercial risk if the associate chooses to leave before the money has been fully clawed back
The payments under the temporary financial arrangements will be subject to adjustment for the reduction in variable costs. The NHS has yet to give a figure for the reduction, or explained the mechanism for reclaiming the reduction – i.e. whether by a lump sum or reductions to future payments. This has left businesses in a difficult position, as variable costs are typically to be shared with the associates. With these not being known at this stage, businesses have a choice either to reduce the monies paid to their associates with a view to topping it up later, or pay the normal UDA rate and then seek to reclaim monies from the associates later. The former approach arguably does not honour the NHS's requirement that associates be paid 'at previous levels', whereas the latter approach carries commercial risk if the associate chooses to leave before the money has been fully clawed back.
Businesses do not yet know what activity they will be expected to perform over the 2020/21 financial year. If we assume a dental business has a contract for 12,000 UDAs, and the measures last until the end of June, you could sensibly argue for two different targets for the remainder of the year:
The NHS has not stated if and how clawback and/or breach notices will operate for 2020/21. This will be particularly important if patients are slow to return to their dentists for routine check-ups.
The NHS clarified that mixed businesses can take advantage of government support, to the extent it does not duplicate NHS-funded income. However, concerns have been raised as to the level of government support for private dental businesses.
The BDA is currently lobbying government in relation to the cap on the Self-Employed Income Support Scheme, which restricts dentists earning over £50,000 through self-employed income from accessing any kind of support.
Concerns have also been raised about the lack of business interruption cover for businesses for the particular circumstances of CovidD-19. The Financial Conduct Authority (FCA) has stated many businesses will not be covered and is seeking a court declaration on behalf of policyholders to bring clarity. The BDA is seeking legal advice on behalf of its members.
In the longer term, fears exist for the future of many smaller dental businesses. A recent survey of BDA members, reported by the Times, suggested one in five dental businesses could close as a result of the financial impact of the pandemic.
According to the BDA's survey of 2,800 practices, 71.5% said they could stay "financially sustainable" for only three months at the most. More than one in five, 20.4%, said they would not survive beyond April. Mick Armstrong, BDA chair, said: "Practices are weeks from a cliff edge. Without meaningful support, the nation’s dental services face decimation."
David Houston said that for those dental businesses that survive it will take, on average, "three years of renewed trading in order to return to fee generating levels to pre-pandemic levels".
Some have argued that predominantly NHS funded business will have stronger financial security through uncertain times, as a result of the government support measures outlined above. The guaranteed levels of NHS income will be reassuring for those dental businesses albeit still somewhat unpredictable until the NHS has clarified financial expectations for the current financial year. The counterargument is that private dental businesses will be better able to be flexible and change their pricing, offerings and potentially longer opening hours.
Pinsent Masons has heard anecdotally that capitation payments remain strong, with a very small reduction in the number of patients. Houston said: "Those private dental businesses that have substantial capitation and payment plan patients will be in a significantly better cash flow position than their rivals." However, he admitted that this is based on the assumption that patients have "been willing to pay having 'missed' three months of service" and "isn’t compounded by many patients’ own financial circumstances". The economic crisis is expected to have an impact on consumer spending, which will test whether dentistry is seen as discretionary spend.
As part of the NHS contract reforms, some dental businesses have been trialling prototype contracts which blend traditional UDA delivery with a capitation payment. The guaranteed revenue stream afforded by the prototype contract may be seen as advantageous to a dental business in these uncertain times. However, it may also help on a service delivery perspective given the new and updated operating procedures require more time to decontaminate surgeries between patients.
Chris Aylward, chief investment officer of Riverdale Healthcare, said that the prototype contract "isn’t perfect but does allow the practice to manage patient needs in a more efficient way which could benefit businesses in the new world". We do not expect to see dental businesses rushing to convert their current NHS contracts to prototypes, but it does appear that the current situation gives the NHS a rare opportunity to accelerate adoption of the prototype or perhaps, even more radically, a wholesale replacement of the NHS contract, to meet with patient and regulatory demand.
Although a number of deals have completed during the lockdown period, the immediate prospects for M&A in the sector have been hit with many deals being put on hold and/or being re-evaluated to assess whether the target dental business and valuations remain aligned. However, as the dental market has seen a host of consolidation over recent years, M&A will remain a core component for many dental groups’ future strategy: indeed, we expect the post-pandemic market to be relatively active with smaller dental businesses looking to sell.
Simon Hughes, managing director for medical at Christie & Co, agrees. He said: "The market will find its level during the remainder of 2020 as the sector comes to terms with its new standard operating procedures and we see what effects, positive and negative, they will have on revenue and costs. Transactions will still continue in the second half of the year but those in the NHS sector are likely to be more fluid than the private sector."
Partner, Hazelwoods LLP
There will be more focus on projections and assumptions and therefore larger elements of deferred consideration will creep into deal structures
The big question post-lockdown will therefore be concerning who exactly will be in a position to buy such businesses – with asset finance likely to be a difficult luxury to secure post-pandemic, we suspect the answer may be private equity-backed dental body corporates. Chris Aylward said: "There will always be a mixture of debt and equity and whilst the ratio may now swing towards equity the ability to invest in the market will remain." Simon Hughes has an equally positive outlook. He anticipates the huge interest shown pre-pandemic will continue and that investors will "double down in the healthcare sectors which will provide more security in the future, particularly the NHS sector".
It is clear that dental groups will have an eye on ramping up their acquisitions as soon as possible. They will, however, have a challenge valuing a dental business in today's market which, because of recent events, has clearly made this a more complex task.
Whilst some operators will place emphasis on the multiples being applied to EBITDA to ascertain price, as was seen after the 2008 financial crash where multiples dropped to around five, others are more concerned with the underlying financials to calculate EBITDA in the first place and a few are predicting almost no change at all.
James Morter, partner at Hazlewoods LLP, said he expects "to see multiples weaken slightly if dental businesses reduce in size due to capacity constraints and their earnings become a little less secure; and a prolonged period of reduced capacity and increased costs as dental businesses exit lockdown will inevitably impact EBITDA", although this doesn’t necessarily mean that wee will see a buyers' market. Morter has predicted that "market forces created by buyer competition may mitigate such an impact and there are plenty of investors out there who will be keen to pick up where they left off". However dental business will be valued, "what is clear is that there will be a more forensic and judicious approach going forward", Hughes said.
We expect there will also be greater scrutiny on sustainability and service delivery. Although sustainability will be inextricably linked to the financial health of dental businesses, we anticipate the pandemic will have highlighted to many dental associates the financial advantages and security owning a dental business brings. This will naturally create a swell of potential buyers, but at the same time principals will be concerned if dental associates seek to leave. However, Chris Aylward said this is "not a new issue for the sector" and unlikely to be an issue that "will become materially worse". He said: "The patient journey has been, and will continue to be, refined and improved such that a patient’s time with a dentist may reduce."
Whilst valuations will always be hotly negotiated, it does also raise the question of whether quality assets will be available to acquire. It is unclear whether dental operators will be willing to sell in times where valuations might be low. Simon Hughes said he expects there will be a "natural pent up demand from sellers who have been unable to market their business during the lock down and they expect a significant increase in new stock coming to the market".
Some observers are predicting the emergence of a new group of sellers: those who have been so financially affected by the pandemic that they either see strength in numbers by joining a dental group, and others that wish to exit dentistry altogether.
Prior to the pandemic, there were reports of 50% of dentists looking to leave the profession, citing burnout. Hughes said: "It is highly likely that a proportion of dental businesses will not have the financial stamina to adapt to the new operating protocols or cannot be future proofed, and the lockdown will have been a period of reflection for many business owners and undoubtedly this will lead to some deciding to sell."
If such a group of sellers does emerge, then there is a possibility that this could see the number of dental deals and valuations rise in the short to medium term. Whoever is selling, there will be willing buyers and confidence in the dental market remains quite strong.
Despite valuations potentially being largely unaffected, it is possible we will see a rise in offers made by dental groups comprising more deferred consideration or earn-out mechanics. These mechanics are typically used where parties are unable to agree on the valuation and a percentage of the consideration payable by a dental group is conditional upon certain financial metrics being met in a period post-completion.
James Morter said: "There will be more focus on projections and assumptions and therefore larger elements of deferred consideration will creep into deal structures." In an uncertain economic situation that makes sense. However, in a competitive process, dental groups will need to consider whether offering an element of deferred consideration will be attractive enough to sellers in this market.
Another avenue which many in the sector will seek to explore is the emerging teledentistry opportunity. With the obvious restrictions and challenges facing traditional dentistry for the time being, the remote provision of services may be an opportunity to increase revenues.
David Houston said: "Virtual consultations have found a place within the provision of care and these may well be retained within some dental businesses’ service offering." Chris Aylward said he expects that lockdown will have allowed "the patient journey to evolve and improve such that it has shown that fast and effective assessments via technology or camera will help a dentist assess the urgency of the clinical need and book a time slot appropriate for the patient to only be required to visit the practice once".
This is not to say that all dentists will be able to take advantage of such innovations – they can be expensive and technical for both the dentist and the patient to use. There is also the need for updates by the relevant regulatory framework that would need to capture such innovations to ensure that, above all, patient safety is never compromised. This may take time. However, as Houston said, "dentistry has always been a profession which is flexible and adaptive".
To contact Paul Krivosic, please email him at [email protected]
05 May 2020