A Chapter 11 restructuring has turned LT Smile Corp. over to the company's private credit provider, a change of ownership that highlights what can happen when talks between private equity sponsors and debt providers hit an impasse.

Benevis, a dental service organization, or DSO, is a subsidiary of LT Smile Corp. that was part of the Chapter 11 filing in the U.S. Bankruptcy Court for the Southern District of Texas in Houston in August.

Ultimately, a credit bid for about $190 million, less the amount of debtor-in-possession financing, prevailed in an auction where an affiliate of New Mountain Capital was the stalking-horse bidder. BMO Harris Bank was administrative agent on a $30 million DIP credit facility.

Pandemic worsened issues
The case sheds light on the fraught negotiations between lenders and private equity sponsors as companies grapple with pandemic shutdowns.

As a DSO, Benevis provides nonclinical support services to more than 150 dental offices. Although DSOs vary, companies of this type have been popular targets by private equity firms and private credit providers in recent years, attracted to high-margin businesses with reliable cash flow, even in weak economies.

Problems facing Benevis and affiliated Kool Smiles dental clinics predated the COVID-19 pandemic. In 2018, Benevis paid $24 million in a U.S. Justice Department settlement over false claims and medically unnecessary pediatric dental services. After that, integration of an April 2019 acquisition led to a liquidity shortfall, according to Benevis court documents.

Finances took a turn for the worse when the COVID-19 pandemic closed dental practices around the U.S. Revenue in the March to May 2020 period declined 68% from 2019 levels, leading to loan defaults.

Pre-petition debt totaled $200.5 million, including a $152.5 million term loan due 2024. New Mountain Finance was the lender, represented by Proskauer Rose LLP in bankruptcy. New Mountain also committed to $5 million of rescue financing in June, in the form of delayed-draw term loan commitments, as part of the bankruptcy process.

Debt also included a $25 million first-lien revolving credit agreement dating from March 2018, court documents show. BMO Harris Bank was the administrative agent. The borrower was LT Smile Acquisition Corp.

Benevis' private equity sponsors, Littlejohn & Co. LLC and Tailwind Management LP, agreed to forbear at least five times beginning on April 30. Despite negotiations, the parties could not agree on how to bridge liquidity needs to pre-pandemic performance levels. The private equity sponsors threatened to liquidate the company via Chapter 7.

Littlejohn and Tailwind acquired Benevis from FFL Partners in 2018.

The sponsors decided to exit their ownership stakes through a two-step process. New Mountain would first buy the holding company equity of LT Smile Corporation for a nominal fee, then bid for the assets through Chapter 11. Jackson Walker and Conway Mackenzie represented LT Smile Corporation, according to court documents. Lincoln International LLC is financial advisor.

Ultimately, no other qualified bidders came forward.

The buyer "will continue to provide its industry-leading, non-clinical business support services to dental practices across the country," New Mountain said in an Oct. 6 statement, adding the company had emerged from Chapter 11 stronger.

The new owner has experience in the business. New Mountain Capital owns another DSO, Western Dental, which it acquired in 2012. California-based Western Dental provides care or management services at 175 dental offices in California, Arizona, Nevada and Texas.

Lenders, not owners
Takeovers from private equity sponsor-owners are typically the option of last resort for private debt providers. And lenders and private equity sponsors insist that negotiations during the pandemic era have been collaborative and cooperative as they work out how to bridge revenue shortfalls.

Private lenders typically focus on receiving full repayment of their loans. However, many private credit providers have added workout experts and say they have added capacity in order to become owners of their borrower companies, if needed.

New Mountain did not return phone calls seeking comment.

In recent years, DSOs have been attractive targets of private equity firms, which have purchased dozens of them in buy-and-build strategies, then cut expenses, such as through shared buying costs on marketing, supplies, lab fees and administrative overhead. Many of them are borrowers of syndicated loans and private credit.

One problem has been private equity firms overpaying for companies. Moreover, many have used add-backs to calculate EBITDA, which might not be realistic. This leaves companies particularly prone to unforeseen business disruptions.

DSOs vary by specialization, geography and balance of private versus government payors, so comparisons between them may not apply. In the case of Benevis, the company focuses on pediatric Medicaid and commercial dentistry services. Last year, state Medicaid and Children's Health Insurance, or CHIP, programs accounted for approximately 70% of revenue, court documents show.

Market trends have since improved compared with the difficult March-to-May period of this year, according to Benevis. In July, general dentistry was about 80% of pre-pandemic levels, court documents show.

Other companies in the space have experienced similar rebounds.

In September, S&P Global Ratings revised the outlook on Heartland Dental LLC to stable and affirmed a CCC+ rating, saying the business was "significantly affected" by closures in the second quarter, but has "since recovered from the trough in April, reporting revenues close to 90% of 2019 levels in July."

Despite the improvement, the long-term impact of the pandemic on these companies is uncertain.

"While revenues ramped up in the summer with clinics reopened and patient volumes increasing, we believe after fulfilling the pent-up demand from earlier closures earlier, risk to the sustainability of future demand in the middle of the pandemic remains," S&P Global Ratings said in a Sept. 30 research note on Heartland Dental. "Until there is a vaccine or cure for COVID-19, the longer-term impact of any change in patient behavior will remain uncertain given the potential for some patients choosing to seek care only when necessary and so the demand for preventative dental care could fluctuate."

Heartland Dental is the largest dental support organization in the U.S. It was acquired by KKR through a $1 billion first-lien term loan and a $150 million delayed-draw term loan in April 2018. Jefferies led the arranger group.