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Drug addiction, insurance rules fuel PE interest in treatment centers

  • Rehabilitation-related M&A rising
  • PE firms deploy capital as insurance regs kick in
  • “There’s going to be a lot of folks who make a lot of money,” says Patrick Kennedy

Heroin, prescription pills and healthcare reform.

That’s what’s driving a growing number of private equity firms into the addiction-treatment business.

In January, North Castle Partners announced a strategic investment in the New Haven, Connecticut, mental-health and addiction-treatment program Turning Point. Audax Private Equity, Deerfield Management Co and Kohlberg Investors executed deals for similar assets in the past year.

“Addiction treatment is really hot right now,” said Jeffrey Roberts, a senior research consultant for NEPC. “People feel like there are these strong tailwinds behind it.”

The Affordable Care Act, popularly known as Obamacare, as well as the Mental Health Parity and Addiction Equity Act of 2008 required insurers to cover mental-health and substance-abuse disorders as they would any medical disorder. Final regulations dictating mental-health coverage went into effect in early 2014.

“It puts mental health on the same plane as physical health. And there can be no distinction between how insurance coverage treats the two,” said former U.S. Rep. Patrick Kennedy, who sponsored the 2008 parity law.

“We’re just beginning to move into the enforcement age of parity. Insurers know they’ll have to up their game to pay for mental health and addiction treatment in an analogous way.”

Obamacare also extended insurance coverage to a broader population, further amplifying demand. The expansion “put a lot of potential money in the system,” said Mark Jrolf, founder of New Heritage Capital.

Legislative tailwinds

Those legislative tailwinds dovetailed with the ongoing addiction epidemic. The overprescription of certain painkillers spurred demand for heroin in recent years, which increased the immediate need for adequate long-term-treatment services.

“What was once almost exclusively an urban problem is spreading to small towns and suburbs,” Nora Volkow, a physician and director of the National Institute on Drug Abuse, told the Senate in 2014.

“This disturbing trend appears to be associated with a growing number of prescriptions in and diversion from the legal market.”

Emergency-room visits for benzodiazepine and opioid-related overdoses spiked more than quadrupled between 2004 and 2011, according to an October report from U.S. Food and Drug Administration researchers. ER visits for younger patients aged 18-24 and 25-34 roughly quadrupled in the period as well.

“The opiate addiction problem in this country — it’s mind-boggling it’s so large,” said Webster Capital co-founder David Malm. “And that has trickle-down effects on the rest of society. Because when people get addicted to heroin, they fall into all sorts of things.”

Those factors contributed to a spike in rehabilitation-related M&A. While volumes have fluctuated, the total number of deals for rehabilitation centers increased in each of the past three years, according to PricewaterhouseCoopers data.

In regards to pricing, EBITDA multiples for existing treatment centers are in the low double digits, private equity and investment banking sources told Buyouts.

The industry also remains extremely fragmented. Several sources described most treatment-center entities as “mom and pop” operations. The largest treatment provider captured just 1.4 percent of the market, according to a December presentation from American Addiction Centers.

Those dynamics provide an opportunity for private equity firms to consolidate regional treatment centers, creating economies of scale for back-office functions and marketing, sources said.

“I think 80 percent of the industry is unconsolidated,” said Malm, whose firm formed outpatient-treatment service BayMark Health Services last year by combining BAART Programs and MedMark Services.

“Up until very recently this was a very out-of-favor segment. There’s headline risk. People just don’t want to deal with heroin addiction.”

Risks of ownership

Indeed, owning addiction-treatment facilities comes with clear and relevant risks. Many patients enter these facilities in a fragile physical state, and many relapse after their initial round of inpatient treatment. Negative outcomes can expose treatment centers to legal or regulatory risks.

At the same time, many insurers are moving toward payment models that prioritize outcomes over processes. Treatment centers that fail to help patients cope with their addictions after they’re discharged will likely fall out of favor with insurers.

“They’re going to want to be able to negotiate with payers by showing payers that they have the whole continuum of care,” said Kennedy, who now works as a mental-health advocate. “You can’t just let people out with a list of 12-step meetings in their area and say ‘go to it.’”

Those problems are further complicated by a diminished pool of qualified substance-abuse and behavioral-disorder counselors, particularly in rural areas, The Wall Street Journal reported in April.

The number of positions in that field will increase at more than triple the rate of all other occupations by 2024, according to statistics cited by the Journal. Labor shortages will extend waiting periods for patients and places greater strain on families coping with addiction.

While those challenges will almost certainly stymie certain private equity firms looking to deploy capital in the sector, sources said they did not expect the deal environment to cool down anytime soon.

“We’ve had decades to fine-tune disease management in every other area of medicine. This is the wild west now. It’s new territory, and it’s vast,” Kennedy told Buyouts.

“There’s going to be a lot of folks who make a lot of money by being the first to plant their flag.”

Photo: A drug addict takes a dose of methadone at Ar Rahman mosque in Kuala Lumpur April 19, 2012. REUTERS/Bazuki Muhammad

Action Item: PwC’s healthcare M&A: