Birner Dental Management has a market cap of $31.5 million and operates a total of 64 dental offices in Colorado, New Mexico and Arizona.

Let's look at what we’re getting for the current selling price of $17.05.

BDMS has tangible assets per share of $5.93. The median ROC (I use CFO/tangible assets) over the last 10 years is 61%. Median ROC over the last three years is 57.6%.

Both figures are acceptable.

So for around $17.00, we’re getting almost $6.00 in tangible assets, which the company has consistently generated around a 60% return on.

In the spirit of conservatism, I’m going to assume they’ll be able to earn a 50% return on tangible assets going forward. A 50% return on $6.00 in tangible assets results in $3.00 of cash flow from operations per share.

Prior to the latest 10-K, filed March 2012, BDMS gave investors maintenance capex. Although they stopped doing this, we have the information needed to calculate it. Historically, maintenance capex has been about 1.25% of revenues. Using 1.5% on average revenues (three-year average) of $33.58 per share we get maintenance capex of $0.50 per share.

Three dollars in CFO minus maintenance capex of $0.50 gives us $2.50 in FCF.

To sum it up so far, we’re paying $17.00 for $6.00 of tangible assets that generate $3.00 in CFO, and $2.50 in FCF. That’s a FCF yield of almost 15%.

What companies do with the FCF generated is probably more important than the amount they generate in the first place. Think of how many companies generate substantial amounts of FCF and waste it on dumb acquisitions or reinvest it at lousy rates of return (HPQ is a great example of what not to do with FCF).

Over the last 15 years, BDMS has generated $44.3 million in FCF. Of the $44.3 million, 95% of it ($42.3 million) has gone to buying back shares and dividends. The remaining 5% ($2.1 million) has been retained.

They’ve managed median year-over-year growth of just under 5% over the last decade. This results in a return on retained FCF of just over 100%.

Obviously, this is very acceptable.

At this point we know BDMS generates FCF, is a good business in terms of ROC, and is shareholder friendly when it comes to allocating FCF.

At $17.00 per share, BDMS doesn’t have to grow for investors to achieve double-digit returns.

Having said that, I think it’s likely they’ll do reasonably well in the future.

I think they’ll do well for a few reasons.

The dental practice management model is designed to be more effective the bigger the business gets. The main advantages of the model over a single practice are advertising and purchasing power. They can spend more on advertising in absolute terms, but as a percentage of revenue per office it decreases. This is also true when purchasing supplies. When buying for more than 60 offices, they’re able to get better pricing than buying for a single office. You often hear of companies touting synergies and the ability to reduce some expenses in percentage terms due to scaling. Fortunately, advertising and purchasing power actually scale.

Management has proven over the last 10 or more years that they won’t do foolish things with capital. They’ve decreased shares outstanding from 6.4 million to 1.9 million from 1998 to 2012 and they’ve paid out a bit over $9 million in dividends.

In my opinion, the only other major consideration is growth and I think it directly relates to capital allocation.

From emailing a few other investors about BDMS, the main concern I’ve heard is what’s going on with the growth. Revenues have been flat the last few years.

I don’t see this as a big issue and I feel it relates to their prudent capital allocation. I think they’re looking for new offices to roll under their Perfect Teeth brand every year. I think it’s as simple as not finding any for what they’d be comfortable paying. This is the fastest way to increase revenues because when they buy an existing office it comes with patients.

They’ve also been developing offices internally. This is another option but one where the benefit isn’t seen until a few years out. If they aren’t finding any suitable acquisitions they then compare their remaining choices. I’d imagine the order being: looking for existing offices at acceptable prices, then opening new offices themselves, and finally repurchasing shares and paying a dividend.

Because they’ve been disciplined allocating capital over a lengthy period of time, I feel very comfortable thinking that in the future there will be years when they buy existing offices and years they don’t. Years they open new offices internally and years they don’t and the the dividends and buybacks will be a function of what they see in the other two categories.

To put it all together, I ask myself, where will BDMS be in three to five years?

This is obviously the point of researching a company. I feel like a lot of discussion relates to the attractiveness of company as it currently stands but doesn’t really address where it’ll be in the future.

I think BDMS will probably grow 1% to 5% per year over the next three to five years. There may be years where they take a step back, but over a three or five year period I think the CAGR will be between 1% and 5%.

Starting with a FCF yield of 15% today and growth of 1% to 5%, I don’t think it’s crazy to think 15% to 17% returns going forward. I am confident that management will continue to allocate capital the way they have.

This leaves investors in a nice position.

It’s currently priced where we don’t need growth to achieve acceptable rates of return, but as I’ve explained, I think they will grow.

Whatever the growth ends up being, at $17.00 per share investors will do okay, and while holding BDMS we’re able to take comfort in the fact that management won’t squander capital.

EDIT: I used the wrong figures when computing the return on retained cash. Return on returned cash is around 15% not 100%

Matt

since you know this company well and I'm feeling to lazy to read financial statements tonight, I thought I'd ask

1) What happened in 2008-2009 that caused their operating margins to get cut in half at the same time that their revenue basically doubled? Just a change in accounting rules?

2) Do you find it disconcerting that they have a dividend payout ration in excess of 100%? I realize it is covered by FCF but you still need cash in the register at the end of the day unless you plan on borrowing from somewhere

Appreciate your time and your article

random afterthought. anything about BDMS roll-up business model applicable to WOOF?

Tony,

1. It was a result of changing their method of accounting relating to variable interest entities. They're prohibited from owning more than one dental office so they sign 25 year contracts with PC's (professional corporations). The PC's own the offices and are responsible for paying the salaries of the dental professionals employed and the remaining money was passed along to BDMS. They restated their filings and now include that amount as revenue, even though they don't technically ever see it, and include the dental professional salaries as an expense. It altered their margins but not their operating income, net income, and fcf.
2. The payout percentages I used were from the period 1997-2011. Over the last 5 years, they've payed out in dividends and bought back shares with an average of 60% of fcf. So the 95% I used was much higher, maybe it would've been more accurate to use a more recent number. That 15 year figure was a bit skewed because they spent $21M in 2000 buying back shares. Over the last 5 the payout has been a much lower %. With that being said, they still have a negative WC position and have since 2004. They have a line of credit they draw on when needed and with their stable cash flows I don't see it being an issue. Interest expense has been covered by CFO 64x, 38x, and 33x over the last three years.
3. I haven't looked at WOOF, I'll take a look.
   My email is on my site, feel free to send over what you're thinking.

Hope this helps,

Matt

Matt - I am also an investor. What are your thoughts/conclusions regarding: 1) the heavy investment BDMS made into Vantage over the past 2-3 years for what looks to be an inadequate payoff and 2) the amount of stock management awards itself? Thanks for your article.

Mps,

1. I don't mind the Vantage investment. The specialty procedures in their traditional offices generate greater margins than "normal" cleaning type procedures and I think that's how Vantage will contribute eventually. It doesn't seem to have added much in terms of CFO over the last two years but I think that can be attributed to the economy. I don't see many people willing to pay for a specialty procedure in this economy. Having said that, I think it could be something that adds significantly to FCF in the future if people are feeling a little more secure. If it does add to FCF in the future that'll be great and if it doesn't I'd hope management learns the lesson and sticks to opening and or buying traditional offices. Basically I'm thinking that if it doesn't pay off it's behind the company and they were able to generate normal numbers while making the needed investments to try out the office and if it does pan out shareholders will reap the benefits.
2. As for the stock awarded to management I'm kind of thinking along the same lines. Obviously it'd be great if they got nothing but their salaries and kept buying back shares, but we can't control that. They do award themselves quite a bit but year after year the diluted share count is still decreasing and shareholders are still being rewarded.

I realize this response doesn't really take a stand on either issue but those are my thoughts. Hope it helps and thanks for the comment. I'd love to hear your thoughts on the issues, if you don't want to post them hear feel free to email me at mtommasiello15@gmail.com.

Matt