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Follow-on deals build out portfolios

November 06, 2017

Ongoing deal activity in the behavioral health sector indicates its sustained, strong position for investment. In fact, private equity interest is accelerating with an upward trend among add-on deals—the secondary transactions that build the portfolio after the initial platform deal.

“One major driver of growth in healthcare-based investment is the deal after the deal,” says Robert Aprill, analyst with Provident Healthcare Partners, an investment banking firm.

In 2016, there were a record 49 follow-on deals in the behavioral health space, according to data from the Braff Group, a mergers and acquisitions advisory firm. In the past, value was attributed largely to size, but that’s changing.

“Today, as at-risk population health and global payment models continue to gain traction, we are likely to see follow-on deals reflect the needs of payers, accountable care organizations and other contractors as they seek to coordinate care over tighter geographic footprints and across multiple behavioral health subsegments,” says Dexter Braff, president of the Braff Group.

Lower transaction value

The multiples in follow-on deals are significantly lower than the original platform investment. According to Tom Schramski, president and managing partner of Vertess, a mergers and acquisitions advisory firm, secondary transactions might involve targets with $5 million to $10 million in annual revenue with adjusted EBITDA of $1 million to $2 million.

With add-on deals, it’s not just about scale or revenue.

“What investors are looking for more and more is to build out the continuum of care,” Schramski says.

Although the secondary acquisitions tend to be smaller in scale and sophistication, the acquiring organizations can benefit from the multiple arbitrage, Aprill says.

For example, a $100 million business formed from a platform deal might go on to acquire a $10 million business, but the acquired asset is instantly worth more because it gains the added scale and other strategic advantages already established in the portfolio. Advantages might include the platform’s existing payer contracts or its technology backbone, for example.

“You might be able to generate higher profits from that business just from leveraging the size and scale of the larger platform,” Aprill says. “It’s no longer a smaller group. It’s now worth more.”

Selling points

There are a number of assets that investors might look for in follow-on deals. Quality and clinical alignment remain first and foremost, of course, but beyond that, investors are primarily seeking transactions that will fill the gaps in their portfolios. It’s particularly true in the addiction treatment space.

“For example, there are a lot of providers that don’t have medication assisted treatment,” says Schramski. “But they’re looking for that now because it gives them a strong advantage, especially if they’re in-network because they’ll get more referrals if they have a more complete opportunity for people to get treatment.”

He says detox is another attractive target right now because many organizations don’t offer the service and because it represents the front end of the treatment model where many patients first connect with care services. The initial contact is valuable because of the potential to serve that patient long-term through the full continuum.

Behavioral health secondary deals can also add competencies with new service lines, such as treatment of co-occurring disorders, says Chris Rogers, managing director at Ziegler, a specialty investment bank. Creating an ecosystem within behavioral health will position an organization to move toward the new accountable-care models of reimbursement.

“To improve patient care, you’re seeing a more holistic approach,” Rogers says. “It’s an offensive move in terms of inpatient care but a defensive move to prove to payers that outcomes are trackable and are improving under the care model the company’s implementing, which will impact how reimbursement discussions go with payers.”

Integration with the health system at large will be the most significant challenge for the future. An organization that is able to integrate behavioral health with primary care would have a strong competitive advantage to leverage with payers, Schramski says.

Investment for growth

Most investment groups are looking to grow and diversify by entering new geographic areas and reaching additional patient populations.

“Generally those investments are well thought out in terms of geographic expansion and what areas in the region make sense,” Aprill says. “And maybe it’s more conducive and financially beneficial to the partnership to acquire a practice instead of building a de novo location.”

For example, he says, a provider that delivers at-home autism services might want to grow by establishing brick-and-mortar treatment centers. Rather than building from the ground up, acquiring a network of centers might make more sense financially.

When considering today’s reimbursement landscape, follow-on deals might bring along an opportunity to leverage the organization’s payer mix as well.

In residential addiction treatment, self-pay has been the dominant structure, but increasingly, more organizations are making the leap to in-network commercial insurance contracts because they see the model as a necessity in the new era of healthcare delivery. An add-on deal could be a viable opportunity to gain or expand in-network capabilities, and experts say that in-network status has become more desirable in the past five years among financial buyers looking for acquisition targets.

However, once a platform has secured in-network status, an add-on that is only self-pay could be brought into the model more easily, says Michael Fassett, analyst with Provident Partners.

“You utilize the payer contracts from the platform’s perspective and apply those to the add-on acquisition for immediate synergy,” Fassett says. “And in behavioral health, by integrating with the platform group, you can be more efficient.”

He says the time required to collect payment from patients or from payer contracts can be reduced as an organization builds scale.

Patient subpopulations

A follow-on deal could bring along with it a new patient subpopulation. For example, the adolescent addiction treatment market is highly fragmented with few platform-sized organizations, Schramski says. And the therapeutic approach to treating that subpopulation needs to be distinctly different and individualized.

“If you have a decent adolescent program with good clinical fidelity, you’re going to be attractive,” he says.

Other emerging subpopulations might include older adults with alcohol use disorders—a market for which there is increasing and unrecognized demand. Many seniors are enrolled in Medicare Advantage plans, which are delivered by commercial managed care organizations and include more services than traditional Medicare.

Finally, experts note that behavioral healthcare executives themselves can be assets in platform deals as well as follow-on deals. A strong leadership team is invaluable to investors because they will rely on the leaders’ industry experience to evaluate potential acquisition targets, identify like-minded clinical philosophies and to contribute to the enterprise growth strategy moving forward.

“Talent gets you through times that money can’t,” says Schramski. “Financial buyers put a premium on that.”

Julie Miller is Editor in Chief of Behavioral Healthcare Executive.

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