Investors asked to open wide for dentistry disrupter

IFR 2299 7 September to 13 September 2019
3 min read
Robert Sherwood

SmileDirectClub has disrupted the cosmetic dentistry industry with its direct to consumer SmileStores and braces that massively undercut the market leader and hopes that success will enable a successful US$1.28bn IPO.

Yet the chunky valuation premium sought to the peer is going to be tough to justify.

JP Morgan and Citigroup are marketing 58.5m shares at US$19–$22 each for pricing on September 11.

“Our initial thought is very bullish, but something is not lining up,” a buyside source said. “They have a lot more questions to answer than they should.”

As with any IPO seeking a lofty valuation, growth is a key issue.

Yes, sales more than doubled to US$373.5m at mid-year from the same period last year but slowing quarterly sales are a matter of concern.

Second-quarter sales were up 10% on the first quarter to US$195.8m. The same comparison in 2018 showed 56% growth.

SmileDirectClub raised US$380m privately in October, with private equity firm Clayton Dubilier & Rice leading the round at a US$3.2bn valuation.

Less than a year later, SmileDirect is targeting an US$8.5bn valuation. The valuation is based on just under seven-times 2020 EV/sales, projecting revenues at around US$1.2bn, and is a big premium to Align Technology at 4.7-times sales.

And CD&R is taking a profit. More than a third of cash is being used to repurchase shares from insiders.

But the space that SmileDirectClub has quickly dominated – termed teledentistry – is compelling.

SmileDirect was formed in 2014 to be a direct to consumer competitor to Align and its product Invisalign.

SmileDirect sells a similar brace – called a “clear aligner” – directly to its customers at US$1,895, a fraction of the US$5,000–$8,000 orthodontists charge for Invisalign and other braces.

More than 700,000 customers have used SmileDirectClub so far. It is active in the UK, Canada and Australia as well as the US.

There is not much competition, with more recent start-ups not close to competing with SmileDirectClub yet.

Crucially, Align is shut out of the space for the next three years. An early investor in SmileDirectClub, Align opened its own Invisalign stores, which an arbitrator ruled in March violated a non-compete agreement.

Align was forced to sell its 17% equity stake and cannot reopen Invisalign stores until August 2022.

SmileDirectClub will be hard to replicate. The company serves its customers online and at 300-plus so-called SmileStores, including in-store partnerships with Walgreens and CVS.

It has also built a proprietary network of doctors that can write prescriptions and provide follow-up care for each patient online or in-store.

There is one other potential regulatory issue to contend with.

“I get the first-mover advantage” said the investor. “What happens if they get regulated as a dentist?”

The company is about to defend a claim from the State of New Jersey Dental Association that SmileDirectClub is a corporate dentist, as opposed to a less-regulated dental service provider.

“Anytime you do something disruptive, the status quo is going to push back,” said SmileDirectClub CFO Kyle Wailes on the online roadshow presentation.

SmileDirectClub will have a chance to answer its critics in the market and in court.

A dentist poses with a teeth model