Volume 8, Issue 19, December 7, 2021
We recently heard of an investor bidding more than 20x forward-EBITDA on a residential substance use disorder (SUD) treatment center with a 30-day due diligence period. This caught our attention. More poignant was that this bidder lost the deal to another investor.
It is no new news that SUD treatment providers across multiple segments are currently worth more than they ever have been historically. When Pitchbook released its 2021 Q3 report on the behavioral health vertical, we learned that in only nine months, more deals and more deal value were transacted than the previous best year on record in 2019. Some experts anticipate 2021 to finish at least 40% higher in both metrics than 2019, and SUD treatment — residential treatment, in particular — makes up a substantial portion of that activity, due to extraordinary utilization of benefits and new product designs from insurance carriers that promote mental health reimbursements such as Anthem’s “Behavioral Health Advantage” plan that is expected to launch in 2022.
There is a long list of trends and developments in the SUD treatment industry that business owners should be paying attention to. In this article, we will focus on the four that we consider the foremost current drivers of the vertical: technology hybrid models, value-based care and population health management, branding, and enterprise valuation.
Telehealth was already gaining momentum in the SUD space prior to the COVID-19 pandemic. Whereas many healthcare segments are limited in this area (e.g., you cannot perform a surgery over Zoom), SUD treatment was a strong candidate for integrating telehealth into existing brick-and-mortar operations. Among the barriers to widespread acceptance of this approach were insurance reimbursements and regulation. For example, how does an operator generate revenue for an out-of-state payor when its contracts are all in-state? After all, healthcare has historically been somewhat geographically bound.
The COVID pandemic resulted in the loosening of regulations for and increased acceptance of telehealth, which created significant momentum in its adoptions. Though commercial carriers and CMS are rapidly catching up to reinforce regulation, that momentum has cemented telehealth in the industry. Combined with the recent Office of Inspector General (OIG) reports that signal permanence of telehealth delivery while calling for strengthening evaluation and oversight of remote care, it appears that telehealth is here to stay.
This is good news from a clinical perspective as clinicians are scarce relative to demand and telehealth streamlines the number of patients they can see in a day. It’s also good for revenues because some of the regulations that were relaxed allow reimbursements to be more friendly to operators. It also appears that lower levels of care — like intensive outpatient programs (IOP) — using digital delivery are retaining clients for longer periods of time as CMS appears to be covering more treatment and patients are choosing to remain in treatment longer since accessing it requires less effort.
The emergence of telehealth is generating salient trends that are giving tailwinds to this industry. For one, investors with a technology mandate can now invest in this space. While it may be unnatural for them, they can still uphold the prospectus in acquiring SUD treatment operators.
For two, the drive toward technology is uncovering new avenues to exploit. Predictive analytics has become a significant area of investment. It is difficult to understand outcomes in behavioral health, but predictive analytics can offer insights into the needs of a patient. Some companies are already deploying predictive analytics.
A third trend driving the move toward technology hybrid models is the larger movement toward value-based reimbursements, which we will discuss next.
The value-based care and population health management concepts behind accountable care organizations (ACO) are nothing new, with several iterations of structuring reimbursements over the past decade and more likely to come. With MACRA, political uncertainty, and existing momentum collectively creating a bullish outlook for ACOs, the discussion of value-based care is one we cannot seem to escape. With the behemoths of the industry investing substantially in quality management, utilization and medical expense, coding and risk adjustment, and population management, the fragmented majority of the industry is slowly following suit.
Of the myriad topics of discussion on developing an ACO, the trend we are seeing that is most pertinent to SUD mergers and acquisitions (M&A) is cross-segment consolidation. Thus far in 2021, non-residential SUD programs were traded at the highest rate in history as providers are aggregating residential, IOP, medication-assisted treatment (MAT), and outpatient programs and even adding specialty areas like services for at-risk youth and telehealth programs. When a provider can serve several levels of care across the continuum — and reach larger populations — it becomes more in line with the value-based care and population health management movement, which is where reimbursement appears to be heading.
Looking beyond the lower-middle market, the major players are indicating strong interest in acquiring ACO-oriented providers. For example, Wayspring recently received a $75 million investment to scale its value-based care solution.
While this article is less interested in exploring marketing strategy as it is M&A trends, the trend in branding marks a fascinating development for locally based providers. Simply stated, sticky messaging requires longevity and frequency of delivery. Locally-based, sub-$50 million-enterprise-value providers have built themes that resonate with their local population. We are seeing acquisitions where the brands of the target provider do not change post-acquisition, which is emblematic of two related trends:
Take a moment to look at the websites for Recovery Centers of America (RCA), Acadia Healthcare, and other prolific buyers. You'll notice how some facilities carry the corporate brand while others remain branded according to the local name.
Considering the historically high valuations experienced by the SUD vertical, there is a fascinating trend that VERTESS advisors have witnessed — and heard others witness — that may be either a short- or long-term trend. The “trailing twelve months” (TTM) income statement has long been the guiding financial indicator for valuation modalities. However, given the turbulent last 12 months in this and other verticals, TTM has given up ground to a blend of historical and proforma financials.
In normalizing financials, advisors create a baseline by excluding and adding adjustments relative to internal and external factors. “’X’ occurred and therefore EBITDA went down; ‘Y’ happened and then EBITDA went up.” The problem is that private equity is sitting on $2.5 trillion of dry powder and having trouble deploying it. Rather than throwing absurd multiples into a letter of intent (reference the >20x deal mentioned earlier), losing deals because of an insistence on leaving Paycheck Protection Program loans in EBITDA adjustments, or adjusting expenses to reflect an appropriate net Income, buyers are occasionally blending financials for baselines to perform a valuation. Instead of 12 months of historical financials, they are looking at 6–9 months of historical and adding 3–6 months of proforma financials to create a more realistic baseline. This is frustrating to buyers who are writing 7–8 figure checks, but it's also refreshing. Why? This shift has created a more collaborative environment to find a fair price, although it can certainly be inappropriate if one party is using the façade of collaboration to push valuation one way or another.
These trends discussed above are only the preeminent developments we are observing in the SUD market and not representative of everything providers are experiencing. Even providers at the forefront of strategizing for and against these developments can lose valuation multiples to buyers who fail to understand the intrinsic value of these assets. Inversely, buyers can overpay for acquisitions that meet strategic initiatives in a frothy marketplace. In this vertical, given the existing market conditions, using a specialized advisor in SUD transactions can add or save several turns of EBITDA in a sale or purchase.
After working in M+A advisory and corporate financial consulting, David co-founded Spero Recovery, a provider of drug and alcohol recovery services with over 100 beds in its continuum of residential, outpatient, and sober living care. As its CFO he led the company to significant revenue and margin growth while ensuring it adhered to the strictest principles of integrity and client care. After selling Spero he remained in leadership with the buyer as its CFO and quickly realized accretion and integration. Of the myriad lessons not learned while earning his MBA with Distinction in Finance from a Tier 1 university, the most profound was the importance of investing in his staff and clients. He learned that the numbers on a spreadsheet represent humans, families, and dreams, which was a radically different paradigm from investment banking.
At VERTESS David is a Managing Director providing M+A and consulting services to the Behavioral Health, Substance Use Disorder treatment, and other verticals, where he brings a foundation of financial expertise with the value-add of humanness and care for the business owners he is honored to represent.