Michael Timoney is the CEO and founder of a business called Smiles Inclusive that listed on the ASX in April this year. It’s a dental practice rollup strategy, there’s a few of them around. There’s a couple that are listed and this one is the most recent and its difference to the others is that it doesn’t buy 100% of the practices or rather it buys 100% and then sells 40% as shadow or phantom equity back to the dentist so their ownership effectively is 60/40, that’s their difference. The others, like Pacific Smiles Group and 1300 Smiles, are buying 100% of the practices and then having a five year earn out usually. This one 60/40 and the dentist stays in. They have just bought 52, they raised 35 million in the float in April, they bought 52 practices. Mike Timoney reckons that they’ll be able to double that in the next 12 months or two years so they’re heading for 100 practices.
The big question is whether they’ll end up in a price war because there’s a price war going on in the US between corporate dental practices at the moment which is obviously squeezing margins. Although their margins are quite good at the moment they’re buying the practices on 20% margin and Mike reckons they can get the margins up to 25% through efficiencies so that’s kind of a positive. But it’s almost inevitable, I think, that they’ll be a price war in dentistry so those margins will come down.
It’s a very interesting investment play, they’re very profitable businesses, dentists, as I say 20% margins on the whole. The share price of Smiles Inclusive has come down a bit from the float, it floated at $1 it’s now 90 cents so I think it’s definitely not expensive and potentially quite lucrative. Certainly, if they get re-rated at the same time as increasing their profit you could see some share price growth.
Here is Mike Timoney, the founder of Smiles Inclusive.
Mike, you’ve just listed Smiles Inclusive in April this year. The idea was to buy 52 practices. Have you done that now, have you bought them all?
Yes, all done and dusted. In fact, we settled on 51. The 52nd one which we didn’t do had about 900 grand turnover and we replaced that with a 3.3 million turnover so we’ve actually settled on more than we indicated in the prospectus from the revenue perspective.
So there’s a bit of a land grab going on with dentistry at the moment, there’s four or five corporate groups, possibly even more, trying to buy up individual dentists. Firstly, what’s different about the way you’re approaching it?
I think first of all let’s take one step backwards. There’s between 9,000 and 10,000 practices in Australia. We think that the level of corporatisation is about 25%. In Finland it’s 42%, in the States it’s 25% and we think there’s less than 5% corporatized in Australia so on that basis there’s still another 2,000 practices that could be corporatized. Whilst I look over my shoulder at 1300 and PSG or even my old group Maven I don’t really see them as a competitor, I just see the sort of 95% in private hands as my main market place.
It’s funny that you say that you’re not a competitor but you are, in a sense, competing against them for good practices, right?
Yes, I mean I think that our main point of difference is our joint venture partnership approach. We’re looking for growth partners that want to join us, we’re not a retirement care home for old dentists who just want to set and forget. We’re interested in dentists that own their own practice that want to come and do a 60/40 joint venture with ourselves and for the next five to 15 years double or triple their business.
Are you the only one that leaves the dentists in the practice with a share of it?
Absolutely, yeah. If I could just talk you through this the traditional dental corporate model has two unintended negative consequences. My old group Maven or 1300 when they acquire a practice they obviously want some sort of comfort because the person selling it – Alan, if you’re selling your practice you want to extract the last dollar out of it, it’s human nature. The buyer scratches around looking for as much reassurance as they can get on the business deal and normally this takes the form of claw back so they hold out 20% of the purchase amount and give them 10% at the end of year 10 and 10% on year four, they lock them into a five year contract. Right from the get go managing that ex-owner is all about negative management, if you don’t do this you’re not going to get paid, if you don’t do that you’re not going to get paid, you’re stuck with us for five years. The second unintended negative consequence is the one of the associates. Imagine, Alan, you’ve sold me your practice. You go home back to your practice and tell your two associates you’ve sold to me, they go great, there’s now no future here for me, I can’t buy into this practice and human nature being what it is they might have not been interested before but now they’re really interested because they can’t have it so you run the risk of them leaving and setting up a competitor making you hitting your targets even more difficult.
Let’s fast forward it to our model. Our model is 60/40, let me just explain how that 60/40 works, Alan. We 100% buy the practice off the vendor and then they simultaneously purchase back the rights for a monthly share in 40% of the EBIT and an exposure to the capital value of that practice up and down.
Why don’t they just retain 40% of the equity, why do you do it that way?
Just from the sheer mechanics of us, Alan, I can’t have 500 companies around the country where I’ve got a 60% stake and they’ve got a 40% stake and you’re managing 500 companies and all the corporate governance that would go with 500 individual companies.
In effect it’s shadow equity, is it?
Yes, or phantom equity you could call it, absolutely yes. It behaves and reacts exactly the same as equity it’s just that we need to have 100% control of the company.
But, do they get capital growth?
Yes, they do. We revalue their practice every six months on an easy five times EBIT and that’s going to generate an up or a down, a bit like sort of a share price that you revalue every six months as opposed to every minute. The key thing here, Alan, is the 40% that the practice owner retains, he can disperse that how he likes. He could offer it for sale at some point to the associates and even the practice manager or even the nurse. For the first time in the world the people unlocking the doors to that dental practice in the morning can have exposure to the equity in that practice whether it’s a nurse, whether it’s a practice manager, whether it’s an associate dentist. That really changes people’s behaviour.
Do you have a right of first refusal or the right of veto?
Absolutely, yes. We’re not in the business of, for instance, having absent landlords. If you held my 40% and you say well I’m going to sell it to my aunt in Perth well that’s no use to me because my whole theorem is I want the people unlocking the door in the morning to have that exposure to the 40% and to reassure the dentist, Alan, we just say that if no one can be found in the short term then we’ll take the position ourselves and then we’ll go and find someone that wants to invest and take that 40%. We’ve already done that once in our short life already, we’ve already done 100% acquisition and then found another dentist who’s interested in taking on that 40%.
That’s right, so you’d never retain the 100%?
No, it’s not our long term strategy of retaining the 100% but we see in certain circumstances short term we might have 100% of a couple of practices while we’re finding a new joint venture partner to sort of buy in as it were.
Do the 40% owners, dentists, do they have a put option back to you at some point or do you have a call option over their share in certain circumstances?
Neither of those and I’ll tell you why, because everything I try and do, Alan, I try and claim in the shoes of the other person on the other side of the table. What I would want as a dentist is to be shooting the lights out with my 40% to then go and have this corporate monster say okay, time to buy you, just when you’re doing really well to have the rug pulled out from under your feet. I’d rather keep moving faster and have 500 to 600 practices where I’ve got 60% then 200 or 300 where I’ve got 100% and less emotional commitment and skin in the game at each practice.
Presumably there’s some triggers in the deal that allow you to take over the 40% in certain circumstances.
Yeah, absolutely. Underperformance. There’s a clause in there that says if they drop by a percentage then absolutely we have the right to pull the trigger and buy them out, and get on with someone that actually wants to do the job, absolutely. What’s interesting, Alan. You know that I set up our dental partners which is now called Maven, took that from zero to 55 practices from ’08 to 2012. The behaviour we’re already experiencing is just day and night. Having a genuine partner at that practice was just wonderful in terms of changed management, really great.
Are all of the 52 practices that’s you’ve bought profitable?
Absolutely. We bought 52 on a five times EBIT, that was our formula and we haven’t deviated from that at all. If they weren’t profitable we wouldn’t have bought them in the first place because there wouldn’t have been an EBIT.
So they’ve all got an EBIT and you’ve always paid five times EBIT, does that mean that you’re not getting into auctions against Maven or 1300 Smiles or Pacific Smiles Group?
Absolutely, and this is what the market was worried about, that all of a sudden us CEOs get carried away and all of a sudden we’re paying six times EBIT or seven times EBIT in some sort of Dutch auction, we’re definitely not doing that. What we have found, Alan, is our business model is quite Darwinian, the people that actually want to carry on working on their business come to us and the ones that just want to hang up their drill and get a cheque go to others.
Right, I see. You’re positioning yourself as a certain type of buyer and you’re not engaging in an auction at all.
Absolutely, in fact we just had five seminars, if you like, at the five Ferrari garages around the country and we’ve had over 600 dentists come through them. Even the one we did last Thursday in Melbourne there was one dentist and I said I’d happily give you the contact details for Maven. He was 72 and he just wanted to sell his practice and sail off into the sunlight and I said absolutely, but I said that’s not our business model but I’m sure they’d be interested in it and here’s their name and number.
It’s interesting, you’re paying five times EBIT. I think you floated the business, your company Smiles Inclusive, at around about five times EBIT, if not exactly that. Now the shares have gone down to, I think, 4.1 times EBIT. What’s going on?
Yes, well first of all we were listed on about roughly a 10 PE, the market sector is on 20 PE so we’re sort of under-priced by 50% if you compare us to Abano Healthcare in New Zealand, 1300 Smiles and PSG. I think it’s just drifted, Alan, because there’s not much news happening at the moment. People will be looking at our very short June 18 results and the market is waiting for reassurance that our 120 day transition plan of getting everyone onto the same computer platform and getting rebranded is going swimmingly well and the synergies of what we’re trying to do start kicking in.
Do you expect that long term your shares will trade at 5 times EBIT, earning before interest and tax, or more than that because of the synergies of scale that you can achieve?
Absolutely, more than that, yes absolutely more than that. I think my personal opinion is today they’re worth double what they are. I think we’re almost a $2 stock now based on what the sector is happy to pay for healthcare and dentistry but we’ve got an unproven management team and despite we haven’t done it before we’ve got to get some runs on the board and we’re pretty confident. My mantra really, Alan, is going back one stage further, is that dentistry is inefficiently delivered to the Australian public. 40% of all my chairs across my organisation never have a bum sitting on them. That cost of capital is being paid by the general public.
Hang on, are you saying that 40% of chairs don’t ever have a bum on them?
Yeah, that’s what we’ve inherited, absolutely. That’s how inefficient the dental sector is at the moment. That’s across the nation.
Why does that happen?
Because dentistry has just come out of 30 years of glorious years of dentistry where you nailed brass plaque outside the door, you’re inundated with patients because there was a lack of dentists in Australia and you just made a motser of money so you didn’t have to be clever, you didn’t have to be strategic and you didn’t have to be efficient. The analogy I draw, Alan, is you remember 15 to 20 years ago you paid a thousand dollars for your airline ticket from Brisbane to Sydney and you sat on a three quarters empty Qantas plane now you pay $100 for the ticket, you sit on an absolutely jam packed full Qantas plane and you probably get a better service. There’s been no victims there, what’s happened is that the airline industry got pulled kicking and screaming to a far more efficient environment than it was before and I see the same happening with dentistry and to the same extent we’ve seen it happen in opticians in Chemist Warehouse, with Spec Savers dragging the whole optical industry into a more efficient business model.
What do you do to make it more efficient, what do you do to make a practice more efficient?
It’s not untypical for us to come across a three or four surgery practice with only two dentists, so the absolute low hanging fruit is to recruit another dentist, get them behind the chair and get bums on that seat. We position ourselves, Alan, as a sales and marketing company that’s doing dentistry not the other way around, not a dental company trying to do sales and marketing. We’re in the business of getting bums on seats and we’re in the business of disrupting dentistry. I see dentistry as a business of disruption, everyone has got teeth, if they haven’t got teeth they need teeth. 65% of Australians still do not readily go to dentists full stop which is just wonderful news for me, that means that I’ve got an audience out there that somehow I have to jolt them out of their daily pattern and get them to come to my dental practices and fill those empty chairs.
Tell us about your sales and marketing then, how much do you spend and what do you spend it on?
We’ve got two aspects. I believe that dentistry has gone retail, so I think it’s become a retail commodity in the same as opticians have. There’s two aspects where we’ll get more bums on seats and that’s internal efficiencies and external. Internal efficiencies is just improving procedures in the dental practices and mining existing databases. Every practice has what we call a million dollar filing cabinet so they’ve got 10,000-20,000 patients names and numbers that they’re not particularly marketing to so we need to get more efficient at that. Then the external is not your traditional, via social media and the traditional forms of getting people to jolt out of their daily activity and come to the dentist.
Do you have kind of a standard percentage of your revenue that you spend on sales and marketing?
I think we’re going to be between 1.5% and 2% of our revenue.
What are the key vehicles for marketing, what are you doing?
Baring in mind we’re only 50 working days old but the key vehicles we’re looking at obviously are social media. We need to leverage the social media. We actually have traditional marketing methods as well, so we’ve got a direct sales force that has pop ups in shopping centres and actually just stops people as they’re going about their daily business and saying excuse me sir, when did you last have a dental check-up, we’d like to offer you a complimentary check-up. Come to our dental practice and let’s have a look at your oral hygiene.
How much cash have you got left?
You mean in terms of burn?
No, out of the IPO raise you bought the 52 practices, have you got any money left after that?
Absolutely. We actually raised debt and equity so when we actually raised the equity we also simultaneously had a $30 million debt position from NAB. We’re going to use that debt position to carry on fuelling future acquisitions and then our marketing and everything we can just pay for that out of normal cash flow. Dentistry is a highly cash flow positive business, people pay before we even pay our suppliers.
Right, but your documentation says you’ve got $27 million cash left so what sort of war chest does that give you for future acquisitions?
I believe that we can double. I think that with debt and cash flow that we’ve probably got another $50 million of acquisitions that we can make. Bearing in mind, Alan, that we are only paying 60% of those acquisitions so out of that $50 million we’re writing a cheque for $30 million.
You’ll end up with 100 or so practices will you?
Yes, I believe that by the time we get to the end of next financial year I think we have every chance of doubling it. I think that we’ll have another 24 in this calendar year.
The average revenue of each practice is a million dollars or so?
Yeah, I think a million dollars, Alan. We’ve got some smaller ones and we’ve got some larger ones but when I do my financial matrix I just sort of scale it on a million dollars per practice. If I want to go from 50 to 100 then I need another 50 million of revenue.
When you buy these practices at an average revenue of a million dollars what roughly is their percentage margin, their EBIT margin?
20%, so we’re roughly buying them at turnover because they’re dropping through 20% and then we time that by five so we get back up to 100%.
Right. What do you reckon you can get that margin up to with your efficiencies?
Another 5%, we think we can push that EBIT from 20% to 25% with synergies, more efficiencies and good marketing put in place.
Therefore in time if you’ve got 100 practices you should be making a $25 EBIT, earnings before interest and tax.
Absolutely, depending on how long those practices have been acquired during that financial year. Obviously if you check them halfway through the year you’ve only got half but if you had them all on day one for the whole year absolutely, we should be pushing through $25 million of EBIT.
How much of that falls to the bottom line, the net profit after tax?
In terms of percentage?
Yeah, I’m just looking at your forecast, your pro forma forecast in the prospectus for FY18, so that’s now finished I guess, we’re now talking on the 2nd of July. It was 5.8 million net profit after tax from 8.7 EBIT, is that roughly kind of what you’d expect?
Yeah, roughly. We’re looking at dropping through to 25% to EBIT and pushing what you just said down to NPAT, yeah.
That’d probably triple your NPAT then wouldn’t it, going to 100 practices you’d probably get 15 million roughly in net profit after tax.
Yeah. If we can improve our efficiency then it’s very low hanging fruit, it has very little overhead attached to it if that makes sense. If you got two chairs flat out in a dental surgery and then we bring on the third chair then the only overheads attached to that third chair is literally the salaries and the consumables of the dentist and the nurse attached to it because all the overheads have already been bought and paid for.
Interesting. Simple business but potentially quite powerful.
We’re just very excited. Also, Alan, I think a lot of strategy being used in retail just aren’t being used in dentistry. You go along to Harvey Norman you expect to walk out with a $10,000 flat screen or a curved screen and a sound bar and you’ve just signed yourself up to 50 months no deposit and interest free. Yet someone sitting in the dental chair gets presented with a $5,000 or $10,000 and they’re expected to put it on their credit card. I think two things that are happening out there, Alan, is people are making the wrong decisions medically through cash flow. Someone will choose to have their tooth ripped out for $200 because they haven’t got $1,500 for root canal which is just a complete tragedy. We need to get in the business of saying for $35 a week have your root canal done, for $50 a week have your teeth straightened, $5 a week have your teeth whitened. Because also what we’ve identified is that Hollywood white smile has become socially divisive, people with that white Hollywood smile are perceived to be more intelligent, more successful, get the better jobs than the guy with the black tooth or the missing tooth ends up being the security guard or the tradie. It’s very hard for those guys to cross that divide but if we can try and bring this down to sort of a monthly payment basis then I think we’ll push dentistry down to a broader base without compromising standards or delivering.
Do you think it’s possible that given the fact that a lot of the practices will end up being owned by corporates, sort of four or five or maybe six powerful corporates, that you’ll end up in a price war?
There is a potential for that. If you go to America there is a price war going on over there. Again I think that will just push us to become more efficient organisations which I think ultimately will benefit the general public. You’ve been around long enough to see how that’s benefitted in air travel, that’s just exploded over the last 20 years because in reality fares just got cheaper and cheaper, haven’t they?
It’s benefitted Qantas but it hasn’t benefitted Virgin, the investors I’m saying.
Absolutely, I think they’re still making a loss or whatever.
It possibly means, doesn’t it Mike, that some of the assumptions about margins might prove to be a bit too robust because a year or two down the track you’re having to slash your margins in order to maintain your market share.
Yes, I think we will come under pricing pressure but I think we’ll be able to counter that by bringing on stream more efficiencies as that happens. I think the main beneficiary is going to be the public with better options and I think we just need to drag the industry into the 22ndCentury and deliver it more efficiently, and I believe we can.
How much of the business do you own, Mike?
16.7% I think from memory, from the prospectus. All my management team have equity and all escrow for a couple of years so everyone has got long term goggles on not the short term goggles.
Right. It’s been great to talk to you, Mike, thanks very much.
Thank you so much for taking time out, I really appreciate that.
That was Mike Timoney, the CEO of Smiles Inclusive.
