Evolving Perspectives: The Dermatology M&A Market in Today’s Environment

As we progress through 2023, the dermatology and aesthetics industries operate and evaluate in a macroeconomic landscape facing developing headwinds. We continue to get questions from independent practice owners about these conditions, the strength of the dermatology and aesthetics M&A markets, and practice valuations. From our current pipeline of clients who are selling their practices, we have identified a few trends:

• Increasing patient counts as we fully exit the COVID-19 era
• Robust financial performance for well-managed practices
• Challenges in finding talent (dermatologists; mid-levels) and rising labor costs
• Continued consolidation and investment activity in the dermatology and aesthetics sector
• Acceleration of M&A activity in the medical-spa industry

To further understand what is happening in the dermatology and aesthetics market, Bundy Group obtained insights from four industry experts. The experts interviewed include:

• Alex Chausovsky--Vice President of Analytics and Consulting at Miller Resource Group
• Kevin Robb--Senior Director, Business Development at PhyNet Dermatology
• Joe Musumeci --Chief Development Officer at Advanced Dermatology & Cosmetic Surgery
• Bill Butler--Chief Executive Officer at DOCS Dermatology

Macroeconomic Headwinds and the Dermatology and Aesthetics Markets

The macroeconomic market has experienced shifting dynamics over the past year, which includes inflation, rising interest rates, and the threat of recession. What impact are these macroeconomic headwinds having on the dermatology and aesthetics markets and your practice’s operations and growth?

Alex Chausovsky: The US economy is firmly on the back side of the business cycle and a mild recession is likely on the horizon because of aggressive interest rate policy decisions by the Fed. But not all is doom and gloom. Inflationary pressure is easing, and consumers remain willing and able to spend money due to a remarkably resilient job market. This should help any recession be mild and relatively short lived.

The unemployment rate rose to 3.7% last month, which is actually a good thing. It means more people are coming back into the labor market and looking for work. The number of job openings is currently above 10 million, suggesting employers remain committed to growth despite fears of a recession.

Bill Butler: Similar to other medical specialties, the most significant impact on our business operations has been employee wage inflation. Ongoing wage inflation has led us to focus our efforts on continuing to optimize clinical operations from an efficiency perspective which we believe will benefit the organization over the long-term. Organic growth at DOCS remains strong amidst the challenging economic climate as demand for dermatological services is exceptionally resilient. Further, we pride ourselves on providing the highest level of patient care in an accessible and friendly environment, which has continued to generate benefits for the organization’s organic growth and ability to recruit top-tier providers within our markets.

Joe Musumeci: ADCS is not immune to these same headwinds and we are being impacted similarly to many of the small practices we evaluate for acquisition. Profit margins are being squeezed due to increasing wages, as well as operating costs and turnover, although turnover is showing signs of stabilization. Additionally, payer reimbursement has been under pressure, so our specialty is experiencing a revenue squeeze alongside the cost pressures. Cost of capital (borrowing) has become significantly more expensive due to rising interest rates, which has slowed overall deal volumes, delayed expansion plans and impacted valuations. Fortunately, ADCS is uniquely positioned to weather these macroeconomic headwinds due to our infrastructure, operating dashboards, economies of scale, and stable business mix.

Dermatology and Aesthetics Acquisitions Today

What is your firm’s view on acquisitions in today’s environment and how M&A plays into your longer-term growth playbook? Are you treating transactions any differently from a diligence, structuring, or valuation standpoint relative to 12 to 24 months ago?

Kevin Robb: First, an appetite for acquisitions. Acquisitions are still a key and critical part of our long term strategy, as we operate with a balance of acquisitions and same-store growth. Second, diligence. Diligence breadth (areas reviewed, including HR/IT/Compensation) and depth (level of detail reviewed) have increased noticeably. Finally, structure. More focus is being placed on long-term alignment with non-owner providers and building incentives for those individuals into deals on the front end.

Joe Musumeci: Acquisitions will still play a large role in our growth strategy going forward, despite the currently sluggish market. Deal terms have become more conservative with regards to valuations, increased equity rollover and reduced interest in sellers who are nearing retirement. Additionally, with the potential elimination of non-compete enforceability, we expect that equity rollover and employment agreement covenants will become more heavily negotiated. The most noticeable difference today versus 12 to 24 months ago is that valuations have been under pressure and are on the decline (from very high levels), notably in smaller-to-midsized practices (< $3mm EBITDA). Larger, more premier practices ($5mm+ EBITDA) continue to fetch higher, premium valuations. Similar to what have seen in the residential real estate market, prices are still elevated due to a 10+ year favorable economic market, but we are treating growth via acquisition as a sustainable, attractive way to continue executing lucrative partnerships in dermatology.

While valuations have retreated from the peak, on a historical basis pricing is still very attractive for potential sellers, so with that being said, the benefit of having a no expectations discussion and going through an initial analysis with a buyer is of great importance as we are finding that current valuations continue to be very compelling.

Bill Butler: Even with the current market environment and level of existing consolidation within dermatology, DOCS is continuing to pursue an active M&A strategy and remains committed to generating a significant amount of our overall growth targets from partnerships with growth-oriented providers who believe in the DOCS vision. With the cost of capital on the rise, we have become increasingly focused on ensuring that each partnership opportunity is not only a good fit from a cultural perspective, but also illustrates a clear path to future growth. Our diligence process remains competent and methodical, but we are deploying increasingly creative deal structures in order to optimize post-close alignment with our partners. On valuations, we anticipate these will continue to revert back to normalized levels relative to what we were seeing 12 to 24 months ago. With that being said, DOCS is willing to offer highly competitive valuations and structures to potential partners who demonstrate a strong strategic fit with our model.

Consolidation is Underway

Are we are in the early, mid or late stages of dermatology consolidation? If we are in the mid or later phases of dermatology practice consolidations, is your platform beginning to consider other ancillary add-on acquisition areas (such as medical spas or plastic surgery)?

Bill Butler: Given the history of consolidation within dermatology over the years, it would be challenging to arrive at the conclusion that we are in the early stages of dermatology consolidation. With that said, we still see plenty of “runway” left and are not hastily attempting to gain scale via acquisitions at the expense of strategic fit and quality. Dermatology is a rapidly evolving specialty which does open the door for additional avenues of growth and consolidation, but at the end of the day, we remain a medically focused group. DOCS has added plastic surgery service offerings to its portfolio in select markets where it strategically made sense, but a more near-term focus is expanding the cosmetics portion of the portfolio in order to complement our existing medical and surgical offerings.

Joe Musumeci: Our thesis is that we are in the middle of consolidation. Dermatology has been “consolidating” for more than 10 years now, which is much longer than many other specialties; however, we still have a long way to go in terms of platform mergers. The specialty is still rather fragmented with 30+ private equity platforms in operation.

There is opportunity in adjacent areas (eg, med spas and plastic surgery). However, this is not a key focus area at this time. We view those as too afield from our business, as our core competency is medical and surgical dermatology. There continues to be significant opportunity within the pure-play dermatology sector which we would rather spend time growing.

Kevin Robb: We are in the 5th or 6th inning of consolidation in the dermatology sector, but we have lots of room to run.