M&A Watch Q2: Pay parity draws investors to behavioral health

By early this year, Illinois had moved nearly half its Medicaid recipients into managed care in an attempt to improve care coordination. For WellSpring Resources, which operates behavioral health and substance-abuse treatment centers in Alton and Jerseyville, the shift served as a catalyst for change.

It had to grow if it was going to have enough negotiating clout to win acceptable contracts from the state's designated managed-care companies. “We realized that we were going to have a lot of challenges ahead of us to reach the dreams that we have,” said WellSpring's interim CEO, Jennifer Craig.

The company engaged an outside financial adviser and launched a strategic review process, which culminated in May with a merger agreement with Centerstone, which operates more than 120 facilities in Illinois, Indiana, Kentucky and Tennessee. The deal also included Centerstone's affiliation with Prairie Center, which provides substance-abuse treatment in central Illinois.

The three-way transaction was one of six behavioral health deals tracked in Modern Healthcare's second-quarter M&A Watch database. The quarter also included three additional deals for companies that offer products and services to behavioral health providers, including electronic health records and specialty pharmacy services.

There also were seven behavioral deals in the first quarter, as well as an additional transaction involving a company that offers revenue-cycle management services to behavioral health providers.

Private equity firms were the buyers in four of the deals in the first half of the year.

The heightened interest in behavioral health from investors comes shortly after new laws giving treatment for mental disorders payment parity with physical illnesses went into effect. Insurers and government payers also are beginning to see treatment of behavioral health disorders as a wise investment in their covered populations since these individuals tend to be high users of costly emergency rooms.

Some of the primary beneficiaries have been facilities that provide treatment programs for substance abuse, eating disorders and at-risk youth. Those centers are now takeover targets for larger companies and investor groups.

“There's a lot of money out there right now that's looking for (behavioral health) investment,” said Colbey Reagan, a Nashville-based healthcare attorney at Waller who previously served as deputy general counsel at Psychiatric Solutions.

The adult residential treatment space tends to attract patients who can pay out of pocket or have commercial insurance. Facilities tend to be more luxurious than a typical psychiatric hospital, Reagan said, with homelike settings, often in pastoral locations.

The business is easy for investors to understand and loosely regulated. Within behavioral health, substance abuse is “the hottest space of them all right now,” Reagan said. “That's just on fire.”

An increase in insurance coverage has also bolstered what used to be a largely self-pay market. The two most significant pieces of legislation for the industry have been the 2008 Mental Health Parity and Addiction Equity Act, which requires group health plans to provide equal benefits for both mental and physical disorders, and the Affordable Care Act, which allowed young adults to stay on their parents' plans until age 26.

States also are paying more attention to substance abuse and other behavioral health disorders. In Vermont, Gov. Peter Shumlin dedicated nearly his entire 2014 State of the State address to opiate and heroin addiction. The following year, New York state Attorney General Eric Schneiderman reached a $900,000 settlement with health maintenance organization ValueOptions (now Beacon Health Options) for allegedly violating state and federal parity laws by denying behavioral health treatments to beneficiaries.

In the financial markets, investors closely watched the initial public offering of AAC Holdings, a Brentwood, Tenn.-based provider of inpatient substance-abuse treatment. The company's shares debuted last October at $20 on the New York Stock Exchange and this month hit a high of $46.60. AAC, which operates as American Addiction Centers, has forged six deals since its IPO.

“Insurance companies are really starting to recognize this as a disease,” said company CEO Michael Cartwright, who is 23 years sober after battling his own addiction. “You're also starting to now see multiple states say this is a problem. You have a lot more people being able to receive treatment.”

The same month that AAC launched its IPO, Acadia Healthcare, the fast-growing operator of psychiatric hospitals, made a $1.2 billion bid to acquire CRC Health, a substance-abuse treatment provider. Acadia followed that deal with its March takeover of Quality Addiction Management for $53 million.

“Once Acadia bought CRC, it demonstrated that the vertical can support deals of this magnitude,” said Erik Kistler, vice president at Edgemont Capital Partners, a healthcare investment bank. “And that was a sign that consolidation could be supported.”

CRC treats 42,000 patients a day in residential and comprehensive treatment centers. With the acquisition, Acadia's payer mix has shifted from 70% government insurance to 35%, Acadia President Brent Turner said during a presentation at Avondale Partners' April behavioral health conference, which brought together behavioral health companies and investors.

Cartwright similarly pointed to the CRC deal as adding more legitimacy to the substance-abuse space, and the capital markets have responded accordingly. AAC in March received a $125 million credit facility that will be used in part for acquisitions.

“There are thousands of these operations that we can buy up over the next five to 10 years,” Cartwright said. “Our field has been highly underfunded for way too long.”

Centerstone, a not-for-profit behavioral healthcare provider, also has been growing rapidly. With WellSpring Resources and Prairie Center, its 15th and 16th affiliations, Centerstone has become an organization with $220 million in revenue. It also is in the confidentiality stage of other deals that could add another $125 million in revenue.

“We're very much on this journey of getting to ideal scale,” said CEO David Guth.

The WellSpring acquisition not only provided Centerstone with additional scale, but gave WellSpring access to the Centerstone Research Institute. As substance abuse centers proliferate in a largely unregulated market, many providers are trying to differentiate themselves with research and data.

WellSpring, for instance, conducted a quarterly evaluation of 435 patients and found that none of them required an emergency room visit or hospitalization despite the high prevalence of comorbidities in the substance-abuse population.

“What was most attractive to us was (Centerstone's) research institute,” Craig said. “It's very difficult at our scale to do that in a scientific way.”

Centerstone also provided additional resources to build its health information technology capabilities, she added.

Vendors that cater to the behavioral health market could be next to consolidate as providers in the space become less fragmented. Kistler of Edgemont Capital Partners said he's personally aware of at least four electronic health-record platforms for behavioral health facilities. “Four can't be making money in this market,” he said.

The uptick in behavioral health deals follows an overall increase in M&A activity in the second quarter. Modern Healthcare's M&A Watch tracked 314 deals with a publicly disclosed value of $176.4 billion. Nearly a third of the deal value came from a single deal in the insurance sector—Anthem's $53.8 billion bid for Cigna Corp.—but providers were the most active dealmakers, inking 41.1% of the quarter's transactions.

Insurance deals also are likely to dominate the third quarter's numbers after Aetna made its $37 billion bid to acquire rival Humana, and Medicaid managed-care insurer Centene Corp. offered $6.3 billion to buy fellow insurer Health Net. Both bids were announced in July.

Although deal volume was 9.1% higher than during the second quarter of 2014, deal value still lagged the prior-year period's $229.8 billion, a peak largely fueled by Big Pharma's tax inversion plays. Nevertheless, the quarter's $176.4 billion was still the second-highest level of deal value tracked by Modern Healthcare's M&A Watch since at least 2012.

Private equity activity also increased in the quarter, with 51 transactions, a 13.3% increase year over year.

Financial investors like the residential treatment sector because it has a straightforward business model and isn't particularly capital-intensive, Kistler said. “Once you've done the initial R&D, it's only pennies to upkeep,” he said. “From a business perspective, you're not going to see things slow down.”

Yet not all companies looking to expand in the behavioral health market have an acquisition strategy. HCA, the largest hospital operating company by revenue, has had a dedicated focus on behavioral health since 2009, said Terry Bridges, the chain's president of behavioral health. The growth opportunity has come partly from its own emergency rooms, where from 2% to 10% of the patients who walk in have a behavioral health condition.

“We're going to continue to grow the psych side of the business,” Bridges said at the Avondale conference. Substance-abuse programs are “part of our agenda for this year,” he noted, but added that the company hasn't made a move yet.

Still, he acknowledged after his presentation that HCA, with its already-large patient base, has traditionally preferred to build new facilities rather than buy them. It can do so more cheaply at $200 per bed compared with buying them at a cost of $500 to $600 per bed.

“We want to see what fits our model” when entering the addiction treatment space, he said.