Demystifying Buyer Interest: Understanding How Business Characteristics are Viewed in the M&A Market for Behavioral Health

By: Vasanta Pundarika, Head of Healthcare Investment Banking, Casey Van de Walle, Director and Barrett Smith, Analyst
Healthcare Investment Banking Group

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For behavioral health business owners considering embarking on a transaction process to sell their business, it can often feel challenging to navigate the sea of information available. Many of the headlines and news articles seem to contradict one other. On one hand, a private pay business generates significant investor interest and a premium valuation. On the other hand, much of the news seems to point toward private pay models as the primary catalyst for a recent bankruptcy.

Part of the challenge is that while companies tackle different cross-sections of the behavioral health market in their own ways, the same applies to the universe of buyers that have varied philosophies on the market and strategy. Essentially, a company that is highly attractive to one buyer may not be as interesting to another. How can business owners navigate these nuances and complexities in positioning their company for a potential sale process? Of course, the most important element is to build a successful business that is providing high-quality essential healthcare. However, beyond that, there are many other key company attributes to consider that are discussed below.

How can a private company position itself to be more attractive in a transaction process?

The first question to consider is: “who are the counterparties involved in the transaction process?”  A decade or so ago, the primary buyers in behavioral health were the larger public companies in the space, such as Universal Health Services (UHS) and Acadia Healthcare (ACHC). However, over the last several years, many private equity firms have become interested in behavioral health and have been driving significant consolidation. There are now several private equity backed platform companies that are interested in growing across the diverse behavioral health services spectrum: in mental health and substance abuse, inpatient, residential, and outpatient care, therapy and wellness, specialty areas such as eating disorders, and innovative treatment models such as transcranial magnetic stimulation (TMS) or esketamine. Additionally, several private equity firms remain interested in starting new behavioral health platform companies.

Key factors that impact whether a company is attractive to buyers in this space include:

• Operations – Clean, compliant operations are more attractive to buyers. Companies with clear compliance policies and operating procedures represent a lower-risk investment for buyers. Further, companies with clean operations are typically better able to withstand and weather challenges.
• Accreditation – Accreditation is a must-have, but most buyers are not particular about which accrediting body has reviewed the company (including: Joint Commission, CARF International, Council on Accreditation, etc.).
• Patient Capture – Strong and consistent patient capture rates that are demonstrable are additive to value. While length of stay or length of treatment varies significantly across behavioral health sub-sectors, the expectation is that patients recover and cycle to lower levels of care or out of treatment entirely. Therefore, buyers are looking for companies that can continue to bring in new patients on a consistent basis.
• Infrastructure – Efficient infrastructure is important for buyers who do not want to inherit extraneous contracts and systems that are unnecessary to the growth of the business.
• Management – Lean senior management teams that are running a clean business are especially attractive to buyers looking for experienced talent. Strong senior management teams with the capability of being nimble to react to market challenges are especially attractive.
• Revenue Cycle – Revenue cycle continues to be a challenge for many behavioral health businesses. A company with consistent revenue cycle metrics, whether the revenue cycle function has been outsourced or is in-house, is desirable.
• Patient Mix – Companies with a diversified patient mix are more attractive. Diversification can include: geography, age, payor, diagnosis, type of treatment, level of care, etc. Patient mix can also change the list of interested buyers. For example, with payor mix, some buyers are highly interested in Medicaid whereas others are only looking for commercial insurance. With age mix, some buyers are only looking for adolescent care whereas others are looking for adult care. Geography in particular is also an important factor for buyers. Companies looking to diversify should consider what the desired patient mix is for their business that would allow for a strong revenue stream despite inherent market risk.
• Quality Metrics – Patients (who are also consumers), referral sources, and payors are all interested in robust quality metrics. Companies incorporating data collection and can demonstrate strong data-driven quality metrics are interesting to buyers.
• Value-Based Care Readiness – Nationally, our healthcare system continues to shift toward value-based care. In behavioral health, risk-based approaches continue to evolve. Companies that have already considered risk and have a strategy for value-based care are a step ahead of the rest.
• Unique, Differentiating Factors – Factors that make a certain business stand out from the others would drive significant interest. Differentiating factors could include strong expertise in a certain section of the population or a specific type of treatment.

Buyers are looking for attractive, valuable opportunities, but also opportunities for synergies and growth. Strategic buyers can find growth through expansion or concentration within a geography, level of care, or patient mix, for example. They may also be looking for complementary businesses. For private equity firms looking for a platform company, an exciting prospect would be a well-run, compliant company with some of the critical attributes described above but with a few improvement areas that can drive rapid growth. Ultimately, business owners looking to position their companies well should consider what the key risks and growth opportunities are for a potential buyer/investor.

What is the best payor strategy: in-network or out-of-network?

When Newport Healthcare, which was focused on the adolescent population and was rumored to have a significant amount of private pay concentration, sold a majority stake in 2021, there was significant market chatter about its high valuation level [1]. Newport is a highly specialized business focused on a very specific market. Not long after, when Delphi Behavioral Health filed for bankruptcy earlier this year [2], many in the market pointed to the company’s luxury private pay model as one of the primary drivers for its decline [3]. Despite somewhat similar revenue models, Delphi was a very different business from Newport, which is a specialized, differentiated business.

While buyers used to be more comfortable with private pay and out-of-network models with a series of single case agreements, there has been a significant shift in market appetite. Unless a business is highly specialized (such as Newport), buyers are more comfortable with in-network or hybrid business models with a significant portion of in-network payor mix. In fact, many buyers will discount single case agreement rates to in-network rates in their valuation analysis.

There are four primary reasons for this shift, among others:

(1) More Availability: Payors are now more willing to enter contracts with behavioral health providers than they were even two to three years ago;
(2) Higher Volumes: Payor contracts can drive additional volumes, especially considering the continuing increase in working, insured patients looking to access behavioral health;
(3) Easier Admissions: Payor contracts can ease the path to admission for a patient considering accessing care, thereby increasing the number of patients; and
(4) Predictability: Payor contracts represent steadier, more predictable revenue.

However, a few key things to note:

(a) Not all payor contracts are created equal: Securing payor contracts with rate levels that do not cover the cost of healthcare services does not add value to a business. Having well-negotiated payor contracts that include rate schedules for different lines of business that cover or exceed the costs of those services is additive to the value of the business. Given rising staffing costs nationwide, covering the costs of services is critical.
(b) Not all payor contracts are relevant: Having several payor contracts that have strong rates, but from which the company does not have a significant number of patients, is not especially valuable unless there is a clear marketing path to access those patients. For example, a well-negotiated payor contract with a payor that covers many individuals in the company’s immediate geography is more additive than one that does not have many covered lives in the company’s core markets.
(c) Payor contracts are not magical: In most markets nationally, having a payor contract does not immediately translate into receiving additional patients covered by that payor. Coupling a strong payor contract with an effective marketing strategy and deep referral networks is imperative to success. While a listing on the payor’s website is helpful, the overall marketing strategy is what ultimately leads patients through the door.
A strong in-network business has well-negotiated contracts with the largest payors in its patient geography, combined with an organized marketing strategy and robust referral networks to produce consistent capture of new patients.

How can a private company’s real estate strategy impact its transaction process?

In behavioral health, the real estate strategy is more of an influencing factor for a transaction process with inpatient and residential businesses. Some buyers and business owners feel strongly that owning both the real estate and the operating company is critical, especially in states with rigorous Certificate of Need, Department of Health, or other licensing policies. Others feel less strongly and there are also business owners and buyers that actively do not want to own the real estate as part of the company. For buyers, this is a common philosophy driven by their private equity sponsor and those that do not seek to own the real estate often have a preferred REIT partner.

Selling the real estate through a sale-leaseback can provide significant capital that is vital to a private business, especially in its early stages or during challenging periods. The two largest, most established companies within behavioral health, Acadia and UHS, own the majority of their real estate. However, when Lifepoint Health acquired Springstone’s 18 behavioral health hospitals earlier this year, it acquired only the business operations as Springstone had previously sold its real estate in a sale-leaseback transaction to Medical Properties Trust (MPW).

The number of healthcare REITs and other real estate companies that are interested in behavioral health or already own behavioral health properties continues to grow rapidly. As this interest increases, there will be more available partners and opportunities to develop a real estate capital model for growth for business owners that need capital to scale their businesses.

Depending on the nature and geography of the business, a sale-leaseback real estate strategy may change the buyer universe. As described, there are some buyers that strongly believe that real estate ownership is essential, and especially in a capital markets environment with higher cost of debt, the real estate capital model may become essential for growth. With this dynamic in mind, a behavioral health business owner’s decision to divest any owned underlying real estate assets should be made carefully in the broader context of the owner’s future strategic goals for the business.

Have you considered your company’s strategic direction and started working on new growth strategies ahead of a potential transaction process?

The impetus for many behavioral health business owners to begin seriously exploring a transaction process is the planned launch of a new growth initiative or strategic direction. While exciting and potentially transformative for a business (and its future valuation), these decisions also pose significant risks, often involving substantial upfront capital, unexpected roadblocks or delays, and/or a prolonged timeline to demonstrate results. Any one of these factors may cause a business owner to accelerate the process of seeking a capital partner.

However, bringing a business to market during a transition period – after implementation of a new strategy but before it starts coming to fruition and producing measurable results – introduces significant uncertainty to a transaction process. In certain markets, buyers would be willing to give some credit for growth strategies not yet completed, whereas in other markets they may not want to absorb that risk.

Depending on the financial projections and up-front cost involved, posing the growth strategy as a potential opportunity may yield greater up-front valuation in a transaction process than a partially completed strategy that has already increased operating expenses without yet bringing the potential revenue. To optimize a potential transaction process, balancing the risks of launching a new strategy and being mindful of your desired outcome and timeline are key.

How is the influx of digital behavioral health solutions impacting private companies looking to transact?

The influx of newer, snazzy digital health companies in the behavioral health space has been constant. Many business owners, excited about the innovation happening in the combination of digital health with behavioral, are keen to get involved. However, like the potential growth strategies discussed above, it is important to carefully evaluate whether it makes sense to build a digital component in-house or to partner with companies already building a digital network. For example, does a business need to spend the up-front capital to make its own application if there is already a company that may be spending significant dollars solely dedicated to developing a similar app? Evaluating the cost and ultimate benefit of an endeavor, such as having a dedicated app, is critical. While digital behavioral health companies garner significant venture capital and market interest, there is also inherently significant risk. Companies should be thoughtful before initiating any large up-front spending in the context of the owners’ overall transaction timeline and goals.

Conclusion: Ultimately, when does it make sense to start preparing to go to market?

The short answer is that it is never too early for a business owner to start preparing a company to go to market. There are many things to consider and refine before making any commitment to proceed with a transaction process. These steps include, among others, undertaking a review of: (i) accounting review and methodology – for a growing business, converting from cash to accrual basis may enhance EBITDA and therefore valuation, (ii) revenue cycle management protocols / efficiency of collections, and (iii) organization of material documentation and contracts (organizational documents, leases, payor and vendor contracts, etc.).

Additional preparation that business owners undertake contributes to the company’s presentation to the market as a high quality, well-managed, strong business that can weather market challenges. This will help garner stronger market interest and best position the company to ultimately achieve its transaction goals.

About Matrix Capital Markets Group, Inc.
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[1] Behavioral Health Business, July 20, 2021, “Onex Partners Finalizes 60% Purchase of Newport in Reported $1.3B Deal”
[2] Delphi Behavioral Health, LLC, Case No. 23-10945, Feb. 6, 2023, United States Bankruptcy Court, Southern District of FL
[3] Behavioral Health Business, March 7, 2023, “How Delphi Behavioral Health Went from Boom to Bust”

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