CLOSE-UP: HENRY SCHEIN – Scheining Knight?

Nov 01, 1999 10:30 PM  By

The next challenge for b-to-ber’s CEO

Whoever dusts the cluttered office of Stan Bergman, CEO of healthcare supplies cataloger Henry Schein, should probably demand more money. Lining the wall-to-wall shelf under a wall-to-wall bank of windows are scores of certificates, plaques, and glass tchochkes – all of them thank-yous given from investment bankers to commemorate an acquisition.

And unless you’ve been living on another planet, you know that Schein has had no shortage of those. In just the past three years, the $2.2 billion cataloger has gobbled up more than 31 companies valued at more than $1.1 billion. Two acquisitions, distributors Sullivan Dental Products and H. Meer Dental Supply, made Schein the largest player in dental office supplies, boosting its U.S. market share from 11% in 1995 to 31% today.

Two other acquisitions, direct marketers General Injectibles and Vaccines, and Micro Bio-Medics, gave Schein a platform to become the third-largest player in physician office supplies, with an 8% market share, just behind Physicians Sales and Services, and McKesson/General Medical. Moreover, a spate of overseas acquisitions has made Schein the top pan-European healthcare direct marketer as well.

These days, Bergman can’t discuss his Melville, NY-based company without sounding more like an auctioneer than a CEO. “This is a seminar program we run with the University of Pennsylvania,” he’ll say, thumbing to an ad in one of Schein’s catalogs. “This is a service we offer called Pro Repair, which is fantastic….We own the biggest podiatry direct marketing company….We’re a very, very important player in the sports medicine business….”

Clearly Bergman, CEO since 1989 and previously Schein’s longtime chief financial officer, loves the art of the deal. “He has been aggressive,” says Jeff Holmes, managing director at Minneapolis-based investment banker Tucker Anthony Cleary Gull. “I think he’s a very smart strategist. From the big-picture perspective, you can’t argue what he has accomplished.”

But as Holmes notes, Bergman still has a critical challenge ahead. While he’s been prolific in buying up companies, he has yet to prove that he can run them. “Now the focus has shifted,” Holmes says, “to getting the operations to perform.”

There’s the rub. Last year, Wall Street had looked kindly on Henry Schein while Bergman put together the pieces of his dental distribution domination. The kindness stopped when Bergman announced last summer that dental sales had dropped 8%, several more percentage points than the company had expected. The stock lost a whopping two-thirds of its value, dropping from $46 in January 1999 to $14 this past October. David Leibowitz, managing director of New York-based investment banking firm Burnham Securities, notes that Schein “has attempted to meld more than one acquisition in a short period. While that may be a good long-term strategy, frequently it comes back to haunt management in the short term.”

Specifically, the problem was in buying H. Meer Dental Supply last year right after purchasing Sullivan Dental Products in ’97. Both companies came with sizable field forces, but many of the sales reps who left during the transition (either voluntarily or through layoffs) took customers with them. Schein has since been playing catch-up, with Bergman assigning senior sales executives to woo back some 3,000 customers who either reduced orders or stopped buying from Schein. “Had Schein pushed away from the table prior to the Meer deal,” says Holmes, “we might not be having this discussion” about Schein’s lackluster stock performance.

Too big a bite

For the time being, it’s clear Schein bit off more than it could chew. Bergman acknowledges this. “Generally when we do mergers, we do shed some of the business,” he says. “That’s calculated when we go in. The thing that went wrong here is that we underestimated the amount of business we would lose.” Right now, Bergman has to focus on consolidating his newly acquired businesses, bringing back customers, and improving efficiencies in order to tell a better story to Wall Street next quarter.

Despite the Street’s spanking, though, Bergman says he has no buyer’s remorse. Like most consolidating catalogers, Bergman feels the path to a better company is through a bigger company. As long as he stays the course – buying and integrating companies – he believes the numbers will prove him right.

“Our strategic plan has three major components,” Bergman says. “The first strategy is to develop economies of scale through internal growth. The second is to add more value to these businesses through acquisitions. And the third is to then take all our customer relationships and leverage them through value-added services” – such as Pro Repair, which offers dentists next-day equipment repairs. In other words, the more businesses Schein acquires, the more products and services it can offer its existing customers – and the more those customers buy, the better Schein’s long-term profit margin.

So far, the numbers bear him out. Factor out the merger and integration costs (which since 1997 have added up to more than $100 million), and the company indeed has shown improved earnings. Operating margins reached 5% in 1998, up from 4.1% a year earlier. Net income increased 40% over the previous year, to $58 million. Schein’s four automated and consolidated distribution centers (in Texas, Pennsylvania, Indiana, and Nevada) were built to operate at only 70% capacity, leaving plenty of room for the company to plug in more sales at minimal cost.

Since 1994, Schein’s top line has grown 41% annually, largely through acquisitions. Right now, Schein has about 75 companies, 300,000 customers, and 60,000 SKUs under its umbrella. In 1998, it sold $1.1 billion in supplies and services to U.S. dentists, $500 million in products to U.S. physicians, and $48 million in supplies to veterinary practices. That’s on top of selling $231 million in healthcare products overseas and $43 million in “added value” services, such as equipment repair.

Long-term debt, meanwhile, is about $180 million, up from $105 million in 1987. Debt-to-equity ratio is about 1:1, which means the company isn’t leveraging itself to buy its way into bigness.

“The basic strategy is a sound one – to put as much volume as possible through a single channel,” says Holmes of Tucker Anthony Cleary Gull. “Henry Schein can add incremental volume very profitably.”

Indeed, “Schein has good margin-producing businesses, and long term, the organization in aggregate will be worth more than the individual companies,” says Don Libey, president of Libey Inc., an adviser to the catalog industry. “The danger is of it becoming so bureaucratic that it slows down and loses operational momentum. But the management seems to be pretty smart. They’re building a very stable platform.”

Becoming number one

This distribution monolith is not the Schein of 20 years ago, or even of five years ago. The 60-plus-year-old company, long known as the Wal-Mart of the dental industry, celebrates its humble beginnings in a display in the company’s Long Island headquarters, where portraits of founders Mr. and Mrs. Henry Schein mingle with yellowed boxes of rheumatism ointment, dental pastes, and snakebite kits. The display next to that, however, shows the company’s current ambitions. Labeled “The Future,” it features the blue-and-red Schein logo superimposed over a glowing map of the world.

Listening to Bergman, it’s sometimes hard to imagine the scope of his strategic ambitions. South African born and educated, he has an optimistic, easygoing, shirt-sleeve presence, and even clips a “Stan” picture ID (sans last name) to his shirt pocket, like any other of the other 6,000 Schein employees. (“They call me Mr. Bergman and I get very upset,” he says.) Bergman adheres to the “Team Schein” concept, which holds that “every employee is as important as the next.” Still, if you had to pick Schein’s number-one cheerleader, Bergman’s your man. “He’s very intense, and he’s constantly thinking of what to do next with the company,” says Susan Vassallo, Henry Schein’s vice president of investor relations.

By 1998, Bergman’s acquisitions had combined the No. 2 (Schein), No. 3 (Sullivan), and No. 4 (Meer) dental distributors in the U.S. market. The former No. 1 distributor, Patterson Dental is now well behind Schein, with 20% market share. (Bergman’s not interested in Patterson, which relies primarily on a sales force. “Besides, the FTC wouldn’t let us buy it,” he says, because of antitrust concerns.) To support and sell the vast array of dental products and services, Schein now mails 7 million catalogs to dentists annually – including a 500-page “big book” – and employs a bank of 250 telesales reps and 580 field sales reps. The reps not only check on product inventory, but also advise dentists on upselling patients (with Schein products) and on better managing their businesses (with Schein software).

Looking overseas

Now that Bergman has seized the North American dental market – what he calls the “lowest-hanging fruit” – it’s clear that he’s planning to do the same in both the medical and overseas markets. Revenue from Schein’s Medical Group, for instance, has boomed 57% annually over the past five years, mostly through internal growth. The company now sells to 30% of all office-based physicians in the U.S. Its veterinary business, at nearly $50 million, is up 18% from 1997. And in January, Schein bought the Heiland Group GmbH, a German healthcare direct marketer, thus establishing a firm foothold in that market and helping to increase Schein’s international sales 27% over 1997.

So far, incidentally, none of these nondental acquisitions have worried Wall Street, largely because they have had no negative effect on earnings or sales. That could change, of course. The way Bergman figures it, the total market for office-based healthcare practitioners in North America and Western Europe is about $11 billion. Half of that is serviced by fragmented, mom-and-pop distributors.

That means Henry Schein has plenty of room to keep buying up competitors – or so Bergman believes. His latest gambit involves staking out medical distribution turf in New Zealand and Australia. “The infrastructure is there,” he says. “It doesn’t matter if we ship veterinary or medical or dental products. We will enter all these markets over time in all these countries.”

Even Bergman, though, acknowledges that he first has to digest Meer and Sullivan before picking up a new set of those executive tchochkes. As far as a new round of acquisitions goes, “we’ve called a bit of a truce,” he says.

But some industry watchers say not to expect this truce to last very long. “Bergman is an aggressive acquirer, and now he has to become an aggressive operator,” analyst Holmes notes. “In the long run, however, if you ask me what his preference is, I do believe he wants to get back in a position to acquire and consolidate.”

Compared to any other $2.2 billion cataloger, Henry Schein has a teeny customer base. Core buyers number only about 300,000 names, and its entire database of healthcare professionals is about 600,000. But what Schein lacks in breadth, it makes up in depth. Because it has integrated its scores of company acquisitions into one operation, it is one of the few healthcare catalogers with integrated purchase history data on each customer. Each time a doctor or dentist buys a new sterilizer, consults a financial analyst, or has a chair repaired, Schein knows about it.

At this point, the company sends out 12 million mailings, which means most customers get something from Schein every week. “What we’ve done well over the last three years is to focus those pieces on a more productive audience,” says CEO Stan Bergman. “We may send a mailing to only 500 dentists, or to 300 doctors. So the key thing is to find out who is buying the razor and who is buying the blade. Our computer profile guides us through what products we would expect a customer to buy, and particularly what he’s not buying from us.”

How well does Schein target its mailings? Most Schein divisions, which have been focusing on getting their existing customers to buy more, have had double-digit internal growth over the past few years. But as with every business, some customers will always resist the mailing onslaught. “I get mailings [from Henry Schein] every single day,” says Dr. Miles Bonom, a Stamford, CT-based dentist. He says he’s not tempted by much of it. Bottom line, he says: “There’s nothing new under the sun in dentistry.”

Next time you’re in a doctor’s office, ask if the doctor has any free Post-it pads. Chances are you’ll be given one sponsored by a drug brand, say, Viagra or the antibiotic Celebrex. You’d be right in assuming the pad was a perk the doctor received from the drug manufacturer. But what you wouldn’t know is that Henry Schein likely handled the distribution of the pads, routing the appropriate drug-branded notepad to the appropriate doctor’s office.

“There’s a 70% chance that the message pad comes from us, and the doctor doesn’t even know it,” says Schein CEO Stan Bergman. Henry Schein handles the distribution because one of its subsidiaries, Targeted Media for Medicine, collects subscription data on 315,000 physicians nationwide and then shares that data with drug manufacturers. “No one else does that,” Bergman says of the message-pad deal. “It’s a silly little business” – though he won’t say how much this silly business collects in sales – “but nobody knows more about what’s going on in the office than we do.”

Henry Schein, behemoth healthcare cataloger, grew from humble roots. Schein was strictly an old-fashioned pharmacy until the mid-1960s, when founder Henry Schein began marketing discounted products – some of which were his own Schein brand – to dentists through a catalog. It was a small but prescient idea. At the time, if a dentist needed a box of drill parts, he or she would call on a local supplier – there were about 3,000 back then – who might get back to the dentist a week later. Schein was the first to offer easy ordering and centralized fulfillment, and at decent prices.

As far as cataloging goes, dentistry proved a compact and juicy market. Even today, the entire U.S. market of office-based dentists numbers about 120,000, a mere speck for a consumer catalog company such as L.L. Bean. Average orders, however, exceed $200, and since Schein offers commodity products, most customers order loyally and frequently.

By the late ’70s, Schein grew to a $40 million business, coasting along on a steady if unspectacular growth track. Within a few years, though, Schein derailed. Blame fluoride for part of the problem: Because fewer kids were going to dentists with fewer cavities, the “drill and fill” business of dentistry – the heart of Schein’s market – started to collapse. Fillings dropped nearly 40% between 1979 and 1990, according to the American Dental Association (ADA).

On top of that, other dental products distributors began knocking off Schein’s discount catalog, stealing market share. By the late ’80s, according to Bergman, Schein was “barely profitable.” That’s when CFO Bergman became CEO (in 1989), taking over the company to perform a financial root canal.

Bergman took a two-pronged approach: Expand and diversify. Within a year, Bergman began selling Schein products in England and Germany. He also started selling dental products to veterinarians (yes, for pets) and launched a medical products catalog.

Meanwhile, back in the company’s core market, Bergman sensed that dentists needed more than a catalog of, as he calls it, “widgets and consumables.” For one thing, thanks to baby-boomer vanity, cosmetic dentistry was replacing drill-and-fill. That meant the dental offices were now in the business of competing for disposable income. At the same time, HMOs and other managed-care providers, in battling for business, began offering discount dental plans as a consumer perk. As a result, dentists’ chairs were filling up again: 75% of adults saw a dentist in 1997, compared to 66% in 1989, according to the ADA. Because of the discounts, though, dentists had to work harder to make the same amount of money.

The way Bergman saw it, Schein could continue to limit itself to supplying drill burrs and latex gloves – or it could also offer dentists opportunities to run a better business. With that in mind, Bergman developed value-added services, such as office-management software, lines of credit, and financial assistance help for dentists who wanted to expand a practice or buy equipment. He also went shopping, snapping up office-consulting practices, rewards and promotions catalogs, large-equipment suppliers, and repair services.

As he opens up a recent Schein catalog, for instance, Bergman turns to a spread of a map of the U.S. pinpointed with 70 red dots. “This is where we have our equipment showrooms,” Bergman says. Schein didn’t build those showrooms, where dentists can try out and purchase chairs and drill units. They came with the Sullivan acquisition two years ago. So, too, did an office-design business, a seminar company, and a number of other dental services. The large-equipment business alone gave Schein a huge leg up in sales, since one-third of every dentist’s budget, according to Investor’s Business Daily, goes to equipment and repairs.

“There is huge opportunity in helping the practitioner run a better business, one that’s more consistent with providing quality care,” says Bergman. “So as Henry Schein moves forward, we are positioning ourselves as more of a solution provider for running the business.”