December 2012 marked one of the busiest months for U.S. M&A activity in recent memory, and the audiology industry made its fair share of contributions. Last summer, we released our mid-year M&A report for the industry predicting that total deal volume for the year would be $60-75 million. We will revise that number upward in this report, because
at least $30 million worth of transactions took place in December alone.
We now believe 2012 accounted for approximately $100 million in transaction volume. Our estimates consider only the acquisition of privately owned audiology or hearing aid dispensing practices in the United States and do not measure transactions involving other entities within the industry. Furthermore, this figure only measure deals initiated in 2012. Many deals involve deferred payments, and millions of dollars were spent covering obligations incurred from transactions that closed in previous years; however, in order to accurately assess deal volume for a given year, only transactions closed in that year can be measured.
History of Industry Consolidation
The audiology industry has experienced numerous consolidation cycles both in the U.S. and globally. The first wave involved the mergers of hearing aid manufacturers, reducing the number of major hearing aid companies to six by the early 2000s. Toward the end of this period, independent retail chains, led by Sonus and Hear USA, made attempts to roll up the industry. Just as their activity began to wane, in the mid-2000s, a few hearing aid manufacturers decided to enter the mix. Consolidation began to escalate until 2008, when the recession cooled things off as buyers became more selective and fewer sellers could afford retirement.
State of the Industry Today
Acquisition activity began to pick back up toward the end of 2010. Deal flow continued to grow in 2011 and the first half of 2012, hitting a peak in the fourth quarter of 2012. This growth was characterized by the largest presence of buyers, perhaps ever, as well as a rush to complete deals by December 31, 2012 in order to avoid the so called fiscal cliff.
Today, a practice owner considering an exit sits in an enviable position. There are as many as eight large, well-capitalized buyers willing to acquire practices nationwide, in addition to the constant opportunities to sell to another practice owner or first-time buyer. The large companies, many of whom are owned by or affiliated with hearing aid manufacturers, continue to lead the way, completing the majority of transactions and offering the most attractive deal terms.
Outlook for 2013
While the torrid pace of Q4 2012 is unlikely to continue, deal volume is expected to remain strong through 2013. Buyer interest remains at high levels as the corporate buyers that led the way last year still have large acquisition budgets and aggressive expansion goals. Furthermore, there are a disproportionate number of practice owners age 50 and older, suggesting that exits for personal reasons will continue to drive sales.
We anticipate that January will be a slower month for deals, as the pressure of the 12/31 deadline eases and buyers recover from the year-end flurry. By the end of Q1, however, we expect the most active buyers to return to a one-deal-per-week pace. Deal volume will likely reach $60-75 million for the year, making it one of the most successful years for transactions in the history of the industry.
Looking further into the future, practice owners can expect another 2-3 years of such demand; however, eventually the consolidation will cool and selling a practice will involve a new set of challenges. Consolidation brings a unique dynamic to any industry, as purchase prices tend to become dramatically inflated while the industry is hot. Today’s audiology and hearing aid practices sell for considerably more than their intrinsic values, at twice the price of comparable dentistry, optometry, or speech pathology practices. Finding a buyer is easy, and a seller’s biggest challenge is negotiating a deal that offers favorable terms in addition to a high price.
If you exclude transactions involving corporate buyers, however, you gain a glimpse of what the future will look like once corporate buyers shut down their acquisition programs. We did an assessment of transactions in which offers were made by both corporate buyers and individual buyers, and calculated the corporate buyer premium to be, on average, 65%. A noteworthy example that was included in the analysis is a practice that sold in Q2 2012 for $1.35 million. The company received offers from three interested buyers; two were corporate buyers, both offering the $1.35 million price that was accepted, while the third was from an individual who offered $800,000.
When the corporate buyers slow down their acquisition programs, and ultimately stop buying altogether, prices will quickly come down. Corporate buyers use a different valuation model than individual buyers. If they are hearing aid manufacturers, the model assesses profitability at both the wholesale and retail levels. Therefore, they can afford to pay more than the individuals. Furthermore, they are more concerned with the big picture, seeking value from the economies of scale achieved through making 100 acquisitions rather than agonizing over the value of each individual transaction.
Owners that miss the consolidation wave can expect a very different selling experience. Finding a buyer will be more difficult, as most will be forced to sell to individuals or other practice owners. Prices will come down, so owners will have to accept that the premium valuations placed on practices today will no longer be realistic. Finally, deals will take longer to close, because buyers will be forced to rely on third-party financing.
Valuations: Purchase prices remained strong for those selling to corporate buyers. Deals valued at “one times sales” or greater still occur; however, only when the buyer is a corporation and most of the time when the deal involves complex terms.
Earn-Outs Bridge Valuation Gaps: Earn-outs are commonly used by corporate buyers to bridge valuation gaps. These are the most complicated deal structures, but do allow a seller to maximize the purchase price as long as the business is able to achieve certain targets in the years following closing.
Owner Employment Agreements: Corporate buyers still prefer to retain the owner for 2-3 years after closing. They pay competitive salaries and many offer benefits, although it is usually a pay cut compared to what the seller earned as an owner. As corporate buyers increase their market share, they exhibit an increased willingness to forego the employment agreements, but typically only if they already have a presence in the market and the owner is not a major revenue contributor.
First In Gets the Lion’s Share: Buyers like to make a big splash when they enter new markets, typically acquiring practices with a minimum of $1 million in annual sales and preferably with multiple locations. They will then complete subsequent acquisitions of smaller practices to bolster their presence, but the first to sell in a market always receives the most lucrative deal.
Brokers Get Results: Practice owners who hire a broker to assist in the sale of their company are receiving higher purchase prices and closing transactions faster than owners who attempt to sell without such support.
Markets: Large, profitable practices will always attract buyers, regardless of the market; however, practices in the top 20 metropolitan areas are the most desirable. Expect to see a continued focus on these markets, especially cities like Chicago and Dallas that today don’t have a strong presence of corporate-owned practices.
Demand for audiology and hearing aid practices it at historic highs, and we anticipate this to remain constant for the next 18 months, at which point it may begin to taper. By 2015, we expect to see the signs of the consolidation wave coming to an end, as buyers will have achieved their acquisition objectives and shift their focus to harvesting profits and improving on inefficiencies.
We do not expect 2013 to match the deal volume of 2012, as unique circumstances led to a dramatic spike in closings in November and December. Looking forward, we anticipate $60-75 million in deal volume for the year, which would make 2013 one of the best in industry history. Practice owners would be wise to explore their options before the window closes.