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This Special Two-Part Series on Private Equity’s Impact on the Optical Market is Supported by Feature Sponsor HPC Puckett & Company.
This is the first installment of a two-part series. To read Part 2, click here.

Call it ‘Opti-mism.’ The pace of new investment and acquisitions in the retail and optometric side of the U.S. optical business has been intensifying. In 2015, that pace picked up dramatically—and more deals are reportedly on tap for the remainder of this year and into the next—promising to essentially reshape the business in new ways, to realign and restructure the national, regional, local optical retail landscape and the presence of vision care in the health care space as well.

Financial experts, retail executives and analysts specializing in optical agree that there has never been a better time to invest in the optical business. With decades of experience in the field, investors who have turned their sights toward the business of vision, say that right now there are especially unique conditions fueling private equity deals and consolidation. In conversations with Vision Monday, experts cited several factors all coming together to create this crescendo: the amounts of available investment money in all sectors, currently low interest rates, health care reform, opportunities for new optical platforms serving the evolving vision care needs of patients, the “good fundamentals” of optical and the steady need for vision correction solutions for patients of all ages.

MONEY AVAILABLE
“We are in a very favorable deal environment, probably the most favorable market for sellers I’ve ever seen in 30 years,” said Mark Goodman, head of Consumer Investment Banking at Raymond James & Associates, one of the nation’s leading investment banks. Goodman has over 30 years of experience advising private and public companies on capital raising and mergers and acquisitions. He and his team have worked with many premier consumer and retail companies and have completed a number of transactions for leading companies in the optical retail sector. He described the general deal-making environment today as “the perfect storm of private equity availability and credit availability than ever before.” Goodman pointed to financial market reports estimating that there is some $400 billion to $500 billion of “undeployed private equity” out there.

Goodman observed, “Following the huge debt crisis of 2008, and the nature of the recovery that followed, combined with low interest rates, the ability to leverage deal value is significant. There are tremendous amounts of cash and banks are anxious to put capital out there. When the economy is doing reasonably well, as it is now, and lenders feel positive, they are willing to lend at a much higher level in terms of loans to cash flow ratio.”

That means, Goodman and others point out, that valuations, as a multiple of EBITDA, which is how all private equity deals are generally measured, can be higher, too. All of this means that those looking to sell may be in a position to negotiate higher prices for their practices.

Chris Harris, of FFL Partners, the group which has been visibly active this year in the optical sector with deals with Eyemart Express and Clarkson Eyecare, among others, said, “We raise money from limited partners’ foundations, endowments, and so forth, and those limited partners are looking for rates of return. Private equity is an asset class where people can generate higher returns, no question.”

Anne Kavanagh is managing member of Kavanagh Consulting, L.L.C. a consultancy that provides M&A, financing, strategic advisory and business development services to the optical industry, as well as a broad array of health care and retailing clients. In a presentation this past spring at the National Association of Vision Care Plans (NAVCP) meeting, she pointed out, “U.S. equity markets have reached an all-time high. The 2014 IPO market was the most active in over a decade, with the highest level of mergers and acquisitions in that time. The mergers and acquisitions market for specialty health care is particularly robust because the Affordable Care Act makes it necessary to increase scale and efficiency while reducing cost.”

About the current climate favoring deals in various sectors, Kavanagh added, “The retail/consumer side is driven by the dollars available (from the consumers, dollars for them to spend), and health care reform requires more efficiency and a lower cost structure.”

Most private equity/investment experts agree that they evaluate economics and management talent, too, as fundamental considerations. When a company can demonstrate sustainable EBITDA growth potential, the investors, owners and management teams will be in a position to optimize their exit. And, yes investments need to present a “viable exit strategy,” either among strategic or other financial buyers. Those holding periods are typically plus or minus five years, all agree.

OPTICAL’S APPEAL
The deals the U.S. optical industry is seeing today are often the result of years of study, discussions and exploration by the major private equity firms and those specialists who work with them. Hunter Puckett is managing director and general counsel, HPC Puckett & Co, a firm founded by his father, Tom Puckett, in 1983. With extensive family and business background in the optical industry, the company is unique in its knowledge, legal and financial perspective about the optical space.

The privately held merger and acquisition advisory firm takes on the role as an exclusive sell-side advisor. In 2014, the firm closed 16 optical sector merger and sale transactions. This year, the firm opened 2015 with more than 20 optical entities under exclusive retainer, the Pucketts said.

Hunter Puckett observed, “Optical is unique, combining both medical and consumer retail, and while this combination can make the sector more complex, it can also make it especially attractive to investors right now.”

Tom Puckett said, “At HPC we strive to maximize the value of our clients’ business while at the same time creating a structure that aligns the owners’ current and future needs with those of the purchasing partner going forward.”

Noted Hunter Puckett, “We work with clients, many over a period of years, to determine what’s best for them, what they really envision for the future. We ask our clients, ‘In a perfect world, what’s best for you?’ it sounds like an easy question, but it’s really not. We’re a family business and understand that many entrepreneurs and vision groups out there are family businesses. We try to bring their expectations and disciplines in line with what the investors are looking for, too. But clearly the interest in this space is higher than ever right now.”

Raymond James’ Goodman concurred, “Analysts are particularly interested in the optical industry for the higher profits they can expect to generate relative to certain other health care sectors. They like the high gross margins in the business.”

The business of vision is also attractive to investors because of its inherent ability to remain profitable even during economic downturns. “They also like the resilience of the sector more so than other retail sectors,” added Goodman, “because it’s a need-to-have item as much as a want-to-have item.”

Another factor affecting the vision market’s desirability is the aging population and its need for more eyecare services and eyewear. “The aging population is also a driver of demand,” Goodman said.

FFL’s Harris, whose father was an independent ophthalmologist, also commented, “In the world of health care, optical is attractive for a variety of reasons since it’s at the intersection of health care and retail. You have interesting aspects of both that make optical better than health care and better in many ways than traditional retail. It’s also kind of ‘recession-resistant.’” Harris noted, “From peak to trough, we observed that there was not as much of a dip as other retailers in other sectors took during the last recession.”

Several years back, Harris acknowledged, P/E firms that might have looked at optical didn’t seem to understand it, tending to want to view it only in comparison to other “known” sectors. “To those unfamiliar with it, optical can just seem different and weird. It’s been fragmented, true, but there are many real opportunities and value to uncover from it.”

Kavanagh added, “All boats are now rising in this economy. But even in a down economy, optical is viewed more favorably than other retail sectors, both on the value side, and the higher-end.”

When asked about the unique nature of the optical market, with its medical aspects, the influence of managed vision care, doctor ownership and state regulations, Goodman said, “The complexity of this market requires private equity firms to take more time to investigate, to get their hands ‘dirtier’ in the optical side of the business than they typically have to do in other more familiar segments. Some might regard that as a bit of a barrier to entry, there is indeed a learning curve to understand this business.”

However, some elements of that complexity could be viewed as a positive. For example, although navigating many managed vision care plans is challenging even for those intimately familiar with operating an optical practice, it could also be seen as a kind of bonus. Noted Kavanagh, “Managed care can act as a marketing tool; it helps reduce the cost of marketing dollars for many in the optical sector, relative to other conventional retailers,” for example.

Scott Werry, of Altas Partners, the Toronto-based firm involved in this month’s acquisition, with Quebec’s Caisse de Depot et Placement (CDPQ) known as La Caisse, of Capital Vision Services LP/MyEyeDr. from its previous equity partner, Monitor Clipper, told VM that the firm had been studying the field for a number of years. He remarked, “We take a longer term orientation to investing, and it’s our goal to be a stable capital partner with the companies we invest in. We were drawn to the optical market because of its opportunity for growth, and we believe that the doctor-driven model in particular has much potential, particularly in such a fragmented market.”

Reade Fahs, CEO of National Vision, Inc. pointed out, “National Vision was public until August 2005 when we were bought by Berkshire Partners, which purchased us and America’s Best at that time. And we enjoyed an incredibly positive relationship with our partners. National Vision really enjoys working in a private environment, especially because the private equity firms we’ve been associated with have been very long term in their orientation; operating with them is not like being a public company, having to live quarter to quarter and take a shorter view.”

In March of 2014, National Vision, the fourth largest optical retailer in the U.S., was purchased by the KKR Group, in a deal estimated by financial news sources as valued in excess of $1 billion. KKR’s Nate Taylor, said at the time, “NVI has a bright future ahead of it, and we are excited to partner with this proven management team on its next chapter of growth. Through its broad store base and leading e-commerce platform, the company is poised to benefit from the growth in this highly attractive value segment of the optical industry. As NVI continues to grow, we also look forward to supporting its important social mission.”

Of the current investment climate, Fahs said, “Healthy deals, like the ones we’ve seen in our field most recently, bring ever increased interest and focus on the optical category.”

That view was acknowledged by Drew Schelzo, operating partner at Acon, and acting CEO of Refac Optical, acquired four years ago, which operates U.S. Vision and Nationwide Vision.“I would say the climate is not any different than three or four years ago. We’ve seen some high profile deals and there can be somewhat of a herd mentality when it comes to private equity; firms will look at deals and say ‘Oh, maybe they are onto something.’”

Schelzo pointed out, “The fundamentals that we saw four years ago are the same as they are today—the industry has strong fundamentals, demographics, the aging population creates good demand, it is still a very fragmented industry, private equity firms are investing to consolidate and fold them up. The margin profile is very strong in eyecare, making it attractive.

“But the other thing going on in the retail industry, in general, is the challenge from the internet, the challenge put on brick and mortar, but you don’t really see that on the retail side in optical as much as you do in general merchandise, for example. You need brick and mortar stores in optical—even Warby Parker is opening stores—this makes people feel that brick and mortar is secure in optical. What tends to work in brick and mortar is specialty, and optical fits that profile, it is a medical device with consultative selling. There is a solid reason for people to come into the store and buy. They may be able to look up something on the web or buy something for a lower price, but they’re not going to buy that way with their eye health.”

Doug Barnes, Jr., CEO of Eyemart Express, which is currently operating 170 stores and will be expanding after the investment of FFL Partners earlier this year, noted, “At a time when many people are viewing Warby Parker and asking what might they do in the future, we feel so strongly that it’s the private practice doctor, new efficiencies, the in-office and in-store opportunities for vision care which is the real up side.”

In addition to the expansion planned for Eyemart Express, which it acquired this year, FFL Partners acquired Clarkson Eyecare, which it purchased in 2014. The firm has also, this summer, acquired EyeCare Associates (ECA), a 19-office optometry practice in Alabama and Pinnacle Optical LLC, a full-service wholesale lab in Alabama.

Anthony Nunn, president of Clarkson Eyecare added, echoing a view shared by others said, “It’s also, frankly, more difficult to be an independent OD today than 15 to 20 years ago. The demands on each independent or regional group is increasingly more complex and burdensome. ODs coming out of school are less focused on ownership and more on lifestyle options as well as their eye doctor focus. Many are saddled with debt. This results in reduced exit options for older ODs, too.”

Another retail executive pointed out, “In today’s competitive retail environment, it can be expensive to invest in new systems and support structures in a business.” And, Nunn added, “It’s increasingly difficult to keep up with the investments and requirements for ICD-10, EMR, and compliance with health insurance companies. Our approach is looking for practices that are more medically based.”

Today, both sides are being influenced to seek consolidation, resulting in a flurry of acquisition activity. On the practice owner side, increased regulation and competition, challenges staying up-to-date with technology, and a desire to leave management challenges behind in order to focus on the patient, are all encouraging them to give up running the business, cash out their own equity yet stay involved with seeing patients.

On the investor side, record amounts of money available at low interest rates, health care reform encouraging efficiencies that come from economies of scale, and practice owners looking to rollover their businesses are all coalescing to form an environment friendly toward acquisition and consolidation.

Combined, the current acquisitive landscape helps answer the question that Kavanagh said every CEO must be asking, “How do I stay relevant?” The proof is in the private equity, putting its money, and lots of it, into optical.