Description

BDMS is a dental practice management company. It has a market cap of $14.8mm, and sells for less than 4x FCF. It is a relatively basic business with stable cash flow generation and low capital requirements.

BDMS was founded in 1995. Based in Colorado, BDMS set out to grow its business by acquisitions and de novo development. BDMS started out by acquiring four practices in 1995 (three of which were the practices of one of the founders). The following year BDMS quadrupled its acquisitions and began developing new offices. The growth continued over the next several years. From 1995 to 1998 (the year in which BDMS came public), BDMS acquired and developed 52 practices and consolidated 3 offices.

However, the growth slowed considerably starting in 1999. Except for the acquisition of the remaining 50% interest in several existing offices, BDMS has only acquired one office since 1999. Since that time it has developed seven offices and consolidated three offices, its last expansion occurring in 2000.

BDMS’ stock never benefited from the acquisitions and de novo development, and the acquisitions had also gotten more expensive. In ’96, the acquired practices cost an average of $370K each. In ’97, the acquired practices cost an average of $350K each. In ’98, the acquired practices cost an average of $580K each. And the sole practice acquired in ’99 cost $760K.

BDMS shifted its strategy from the expansion of new capacity to the greater utilization of existing capacity. Currently, its total office count is the same as in 1999. From ’95-’99, BDMS increased net revenues from approximately $5mm to nearly $29mm. BDMS had also accumulated close to $7mm in debt--BDMS relied principally on cash and notes payable to fund its acquisitions. Since '99, without an expansion program to spur growth, net revenues have pretty much hovered around $29mm-$30mm. A focus on cost reductions and profitable office management, and the benefits received from cutting debt and interest expense in half since BDMS shifted its strategy in 2000, however, have positively impacted income and cash flow.

From ’00-’02, contribution from dental offices increased from $3.9mm to $5.1mm. Operating income increased from $197K to $1.8mm. FCF increased from $620K to $4.4mm.

With its dental offices already established, BDMS has been able to plow its cash flow into share repurchases. In 2002, BDMS purchased 117K shares of stock worth approximately $1.2mm. During the first nine months of 2003, BDMS purchased 274K shares of stock for $3.7mm. There are currently 1.2mm shares outstanding.

As a management company, BDMS supports a network of dental offices in Colorado, New Mexico and Arizona. It markets its offices under the Perfect Teeth brand, and is the largest provider of dental care in Colorado and New Mexico. BDMS manages the business and marketing aspects of its dental offices. It provides capital, implements marketing programs, handles purchasing, staffing, recruiting and training of non-dental personnel, billing and collections and legal and accounting services. It also handles the negotiations with managed care organizations.

While the acquired practices are located in shopping centers, professional buildings or standalone buildings, the majority of the de novo offices are located in supermarket-anchored shopping centers.

As a management company, state laws prohibit BDMS from technically running the dental practices since BDMS cannot employ dentists. Therefore, each office is run by a professional corporation (PC) that is owned by a licensed dentist. BDMS then derives its revenues from management agreements with the PCs. The PCs are responsible for supervising the dentists and hygienists, ensuring legal compliance and maintaining patient records.

BDMS essentially gets paid the revenue generated by the PC (with adjustments for uncollectible accounts and non-fee items) minus the salaries for the dentists and hygienists. BDMS then must incur all the direct and indirect costs related to its management services, allowing BDMS to manage the profitability of the offices.

BDMS has been increasing its fee-for-service business, which generates higher margins, and decreasing its capitated business, which serves to increase facility utilization. Capitated managed dental care contracts provide a fixed monthly fee per member regardless of the quantity or cost of services performed. Capitated contracts accounted for 27.5% of gross revenues in 2002, down from 51.4% in 2000. Of the 27.5% in 2002, 13% came from capitated managed dental care contracts and 14.5% came from associated co-payments.

Established offices are staffed with one to three dentists, and de novo offices are staffed with one dentist. When a de novo office develops enough of a patient base to justify expansion, an associate dentist, typically a recent graduate, is brought in to work with the managing dentist.

Sales growth for BDMS is going to be relatively stable, as long as it continues its focus on primarily managing the offices. Net revenues have ranged from approximately $7mm-$8mm per quarter since the start of 1999.

BDMS receives net revenue from the consolidated offices, which is basically the dental practice revenue less compensation for the dentists and hygienists. In the first three months of 2003, the contribution from the dental offices (net revenues less dental office expenses) generated an 18% margin. BDMS’ focus on cost control and greater capacity utilization has enabled the contribution margin to climb to the current 18% from 13.4% in 2000. Control of G&A expenses has allowed BDMS’ operating margin to increase from less than 1% in 2000 to nearly 7% in the last nine month period.

Although revenues are flat/stable, BDMS’ dental offices are cash generators. OCF was $4mm in '01 and nearly $5mm in '02. Now, to get to that, BDMS has been squeezing working capital. Working capital management has contributed about $1mm per year to operating cash flow over the past two years. Trailing cash flow is $4.4mm. Maintenance capex over the past two years related to the purchase of property and equipment has been around $500K-$550K per year. Trailing capex is approximately $420K.

BDMS has trailing net revenues of $30.4mm, diluted earnings of $.72 per share, operating cash flow of $4.4mm and free cash flow of $4mm. It trades for .5x net sales, 17x EPS, 3.4x OCF and less than 4x FCF. (Define free cash flow by EBITDA-interest-taxes-capex and BDMS sells for less than 5x FCF.)

The three founders, CEO Frederic Birner, President Mark Birner, DDS and CFO Dennis Genty, own approximately 42% of the stock. Mark Birner owned and operated three dental practices prior to the formation of BDMS. His brother Frederic Birner and Dennis Genty worked as VPs in corporate finance at Cohig & Associates.

Together, they founded BDMS in 1995, based on a strategy of growth. They switched strategies in 2000 and began focusing on the existing offices in the network. Cost reduction and capacity utilization became management's new focus.

Without having to plow capital into acquisitions and de novo developments, management has reduced BDMS' debt and increased share buybacks. As long as BDMS continues with its current strategy of primarily managing its network of offices, it can stay focused on costs and capacity utilization, and enjoy the benefits of its cash-generating dental offices. BDMS is very attractively valued, and will become more so with continued share buybacks.

A risk is if management starts ramping up expansion and overpaying for acquisitions, increasing leverage and costs. This would be a departure from management's focus of the past several years, however. But it is still a risk.

Catalyst

The main catalyst for BDMS is its valuation and free cash flow generation. It is a stable business that is able to pound out significant free cash flow in relation to its market cap.