Transitioning from Aggressive Acquirer
to Efficient Operator
Roll-ups and acquisitions were all the rage during the last decade of the 20th century. Now into the second year of an entirely new century, aggressive acquirers are paying their dues. They’re realizing that the pursuit of aggressive growth strategies to satisfy unrealistic capital market expectations came at a big price: sizeable reductions of both cash flow and shareholder value. This article describes what a company needs to do to transition from being an aggressive acquirer to an efficient operator of the assets it’s already acquired. Additionally, it’s a case study of one roll-up company that took advantage of a window of opportunity, became bridled with increasing debt in a deteriorating capital market, and found itself facing an immediate and major transition.
InterDent had a voracious appetite.
When InterDent first formed from a merger of two dental practice management (DPM) companies in 1997, it had 44 dental offices. With that base, InterDent had a distinct window of opportunity to lead the industry, consisting of both attractive roll-up targets and accessible capital markets. Choosing not to miss this window, the company proceeded to acquire at an amazing rate, growing over 500% in only three years. By 2000, InterDent had 244 dental offices throughout the States, and had become the largest DPM in U.S. history.
Correspondingly, the company grew to $360 million in total annualized patient revenue with about $33 million in EBITDA (earnings before interest, taxes, depreciation, and amortization). In financing the acquisitions, the company’s total debt ballooned to nearly $180 million. With that, annual interest expense approached $20 million. Given that the company needed at least $7 million annually for necessary capital expenditures, an insufficient $6 million remained to repay bank principal and seller debt (see Exhibit 1). During this same time, and to the obvious disappointment of the company and its banks and investors, the originally anticipated and now sorely needed equity markets had simply dried up.
And so InterDent found itself in a very difficult but not unique situation, particularly in an environment of tightened capital markets. It was unable to attract additional capital to further fund an acquisition strategy, and generated insufficient cash to service the debt it had accumulated as a result of its past acquisition strategy. Like many troubled companies, InterDent needed to quickly develop a turnaround plan both to improve its cash situation and restructure its balance sheet. But in addition to a turnaround plan, a company transitioning from aggressive acquirer to efficient operator needs two more things: it needs to establish efficient infrastructure, and it must change it’s culture to emphasize introspection, accountability, communication, standardization and control.
Acquirers-turned-Operators need to analyze fast and proceed quickly.
During the time a company pursues a singular strategy of acquisition, it relentlessly focuses on either new markets for current offerings or new offerings for current markets. Responding to success in its acquisition strategy, the company then aggressively recruits and throws new staff in the mix to somehow handle this newfound growth. It’s an exciting time, with everyone watching both revenue and hopefully stock price climb. But while acquiring is exciting, unfortunately neither attractive opportunities nor accessible capital markets are everlasting.
At least one event eventually serves as a “triggering event” to bump these companies off their singular strategy of acquisition. This triggering event might be a reduction in attractive opportunities (e.g., affordable new acquisitions have dried up), a tightening of capital markets (e.g., sources of new funds have gone away), a shifting of industry economics (e.g., pricing or cost structure has dramatically changed), or simply a realization that planned consolidations and internal efficiencies have not materialized (e.g., generating insufficient cash to service the financing of past acquisitions or newly accelerated amortizations).
But for whatever reason, the company comes to the conclusion that its acquisition strategy must be placed on hold, and that new strategies must be set in motion. It’s typically at this point that companies realize that, while they’ve made some great acquisitions, they’ve not taken the time to focus on efficiently running the business of every day operations.
Given this realization, and because triggering events rarely leave lots of post-event breathing room, these companies must quickly assess their situation, develop a turnaround plan, and launch remedial initiatives. The faster they move now, the more opportunities and options they’ll be able to consider in the future.
At InterDent, no fewer than five triggering events coalesced in late 2000 to serve as its rude awakening: 1) the cyclical healthcare industry was in a down-cycle, 2) financial markets had tightened, 3) the company was highly leveraged, 4) it generated insufficient cash to repay loans according to newly prescribed terms, and 5) it faced both internal and external perceptions of deteriorating operating performance.
In that environment, and with associated new obstacles of bank, consulting, and legal fees, InterDent quickly proceeded along two fronts. The company divested its Eastern operations (80 offices totaling $70 million in sales) to provide immediate cash infusion. It wanted to buy time to accomplish operational improvements, starting with launching a QuickStrike ® assessment. InterDent needed to determine if it could meet its continuing obligations given baseline EBITDA plus any potential improvements it might identify. With a small but very experienced team, including its most senior executives, InterDent created a turnaround plan within the first four-weeks. Management realized they could in fact make significant improvements, but also realized they needed to financially restructure the business (e.g., fix the over-leveraged balance sheet). And they knew they could only do that once they generated what they began to term as sufficient internal “self-help.”
InterDent’s plan included four very focused teams implementing a total of 18 initiatives – each with specific scope, goals, budget, work plan and supporting analyses. After ten months, the teams have realized significant results:
1) The Office Profitability Team focused on closing negative EBITDA offices and turning around under-performing ones. Using a scorecard approach, in conjunction with a traveling SWAT team for implementation, they’ve logged $2.5 million in verified annualized benefits to date. They’ve hired specialists to enhance revenue where practical, and have improved efficiency in targeted offices.
2) The Managed Care Team focused on analyzing and negotiating for increased insurance plan reimbursements. The team has developed the reports necessary to justify and monitor increases in reimbursement rates. They’ve met with over 20 major plans, and to date have generated approximately $1 million of annualized improvement with much more on the horizon.
3) The Overhead Reduction and Working Capital Team completed a number of initiatives, ranging from accelerating collections (accelerating over $4 million to date by sending 11,000 collection letters), reducing corporate staff positions, implementing over 20 on-line policy documents to improve spending control, and reducing telecom expense by eliminating lines and expensive services. To date they’ve logged over $2 million and nearly $1 million in annual and one-time improvements, respectively. They’ve recently launched another initiative that should have major impact on purchasing efficiency – Electronic Data Interchange (EDI) for key vendors.
4) The Procurement Team focused their efforts on three key areas: creating a single and standard on-line formulary from which all offices order dental supplies, reducing the number of lab vendors across the company by over 50%, and negotiating pricing and terms with remaining vendors. When full implementation is realized, they should have driven over $2.5 million to the bottom line.
They need to establish efficient infrastructure.
Acquirers-turned-operators need to not only get a quick handle on cash, but unlike many turnaround situations, they need to establish efficient infrastructure. For the most part, roll-ups need to build new infrastructure from scratch, having rolled up “mom-and-pops” with little to no scaleable HR, Finance, Reporting, Back-Office, and other fundamental processes. And acquirers of larger companies need to purge and consolidate; they need to consolidate to a single infrastructure from their redundant set of fundamental processes. Aggressive acquirers rarely took the time to do this. And as long as revenue continued to increase at an accelerated pace and capital was accessible, they never had to. Simply no one focused on the housekeeping.
But when funds dry up and the acquisitions stop, people ask about housekeeping. And so acquirers-turned-operators must develop the infrastructure necessary to enable efficient day-to-day operations. It’s efficient day-to-day operations that will improve cash flow to either service existing debt or to attract new equity investors to de-leverage the balance sheet.
Just as important, they need infrastructure to prepare them for yet another day of accelerated growth. Consider it this way: triggering events cause acquirers to “take a break” from acquisitions, clean house a bit, build infrastructure, and prepare for future growth that will once again attract the interest of the investment community.
Because money at this point is always tight, it’s critical for the company to prioritize infrastructure investments. Companies will typically prioritize two areas: processes that are sorely inefficient (e.g., cash sink holes), and processes that are mission-critical to their type of business.
At InterDent, after first realizing initial success with its core EBITDA improvement teams, management initiated efforts focusing primarily on shoring up mission critical processes:
Infrastructure Development efforts at InterDent are focused on positioning the company for future growth once the core turnaround plan is complete. It’s efforts include 1) reducing historically high dentist turnover by implementing an industry-unique career development and compensation approach, 2) improving staff capabilities through standardized front office training, 3) reducing insurance costs by changing to a more effective broker, 4) improving the quality and timeliness of financial reporting through reorganizing and reengineering the financial department and reporting process, and 5) consolidating Central Billing Offices (CBO), and standardizing and augmenting the services they provide (historically only two-thirds of its offices receive billing services from one of seven non-standard CBOs; in the future all offices will receive billing, insurance, payroll, clinical credentialing, staff training, and perhaps scheduling services from one of only three standardized CBOs). InterDent’s new Southwestern CBO is scheduled to open in July, replacing two CBOs as well as other dispersed functions across the Southwest.
And they need the right team to start cultural change.
Aggressive acquisition companies tend to have fast-paced, externally facing cultures. They’re focused primarily on deals. They typically reward their people based solely on growth: securing new financing, buying new operations, and obtaining new customers.
Alternatively, efficient operating companies are interested in streamlining processes, organizing for clear authority, communication, and control, and making daily incremental improvement. They reward for both growth and efficiency, and therefore tend to have more introspective cultures. (See Exhibit 2).
Aggressive acquirers and efficient operators are rarely of the same breed. When they realize they need to become efficient operating companies, acquisition companies realize they’ll likely need to trade players, starting at the top. The leaders of acquisition companies might be excellent networkers and salespeople, fine financiers, and great visionaries. But those same people are typically less interested in process and infrastructure, accountability and control, and daily incremental improvement. And so, enter the operator.
InterDent realized acquirers and operators are of two different breeds, and that it needed a cultural shift to one that values internal operating efficiency, internal communications and accountability, and ongoing process improvement. It made several key staff changes, realizing that those would be the start of a slow but critical cultural shift:
Staff Improvement Efforts at InterDent included a number of key positions. InterDent replaced its very capable but acquisition-minded CEO with an operations-focused CEO from its Board of Directors. It replaced its CFO to provide more effective communication focused on financial restructuring, and replaced its VP of HR with a new Manager. InterDent eliminated its business development group, having no acquisitions on the horizon, and reorganized its HR & Finance departments to better support operations.
InterDent made some key investments too. Management brought in a Special Assistant to the CEO to focus on Operations, leading the internal improvement initiatives. They initiated a Dental Advisory Board early in the process to provide both a clinical perspective to operational initiatives and leadership to the broader clinician group. Because insurance plan management is so fundamental to the business, they hired an experienced Director of Plan Management. Management eliminated a regional recruiter position, while reassigning a Senior Vice President to better coordinate clinical recruiting across all offices. It hired a Director of Training to support the development of all professional staff. In the area of regional and office management, InterDent executives have been and will continue to be evaluating and upgrading management staff across all regions. And as they go, they’ve been transitioning both clinical and management staff to more variable, pay-for-performance, compensation schemes.
The new management team has spent a lot of time on internal and external communication. In situations like these, the rumor mill runs rampant, and without open and ongoing communications, negative perceptions only escalate. Understanding this, management launched a series of “road show” meetings, to openly discuss current events and future plans. It conducted its first annual National Conference (sponsored by vendors to minimize cost), for the first time pulling together over 150 senior dentists and regional and office managers.
With its recent staff changes, incentive compensation enhancements, and focused communications, InterDent is well on its way to creating a culture that truly values efficient operations.
Summary: Enabling a return to growth strategies.
Whether they are a “reduction in attractive opportunities,” or a “tightening of capital markets,” certain triggering events can cause a company to need to transition from being an aggressive acquirer to an efficient operator.
When acquirers-turned-operators 1) analyze fast and proceed quickly, 2) prioritize the building of infrastructure, and 3) establish the right team to initiate cultural change, they dramatically improve their chances of completing this transition successfully.
And when successfully transitioned, these companies provide themselves with a number of future opportunities, including the option to again pursue grown through acquisitions. But the next time, successfully transitioned companies can grow based on solid supporting infrastructures and efficient operating models.
InterDent’s transition is only partially complete. Things are in place, and more gets done with each passing week. They’re certainly heading in the right direction. The company recently (April 2002) announced the successful amendment to its credit facility, in which its banks have agreed to substantially reduce principle payment obligations through the end of the First Quarter of 2003, allowing the company time to complete its transition and restructure the balance sheet. Without the “self help” it’s achieved to date, InterDent would not have been able to realize this milestone.
They’ve already begun attracting even unsolicited interest of investors again. The company is well on its way to a successful turnaround, and with any luck will resume a growth strategy in the near future, attracting renewed attention from the investment community. But next time they’ll do it with the support of solid infrastructure and an efficient operating model.
Exhibit 1: Financial comparison from early to late in the acquisition cycle - InterDent
* Earnings before interest, taxes, depreciation, and amortization
Exhibit 2: Comparison of typical acquirer and operator characteristics*
* Obviously these are generalizations for illustrative purposes only
- Professionalism - Commitment - Results