Across behavioral health, dealmaking and investing in 2022 likely won’t reach the remarkable levels seen in 2021.
Regardless, there are several reasons to expect that this year will continue to demonstrate that the investment and M&A markets are on the side of behavioral health providers, according to Dexter Braff, the president of the M&A firm The Braff Group.
Even when considering emerging trends and environmental factors tempering dealmaking activity, such as interest rates going up and the threat of an economic recession, the powerful macro-level drivers that lead to 2021’s banner year for behavioral health investment and dealmaking firmly remain in place.
“The reasons why people needed to buy are still there, which is the primary reason why we’re so bullish on the space,” Braff said while speaking at the Behavioral Health Business INVEST conference on Wednesday. “Anything negative that’s going to happen in the economy will not be negative enough to take away from buyers’ interest in planting seeds in a market where they need to get market penetration when it’s available — because other people are doing it too.”
One of the macro-level drivers: value-based care and the rollout of various alternative payment models across health care.
Alternative payment models touched off a more-than-decade-long streak of M&A and investment activity in health care services, including in behavioral health, Braff said. He added that this is the most powerful driver of M&A and investment in all of health care.
Harkening back to the passage of the Affordable Care Act during the Obama administration, the creation of bundled payments and the CMS Innovation Center ignited mass experimentation of what may be today considered value-based care models: bundled payments, accountable care organizations (ACOs) and more. These concepts all sought to derive greater value from health care spending by compensating for care in innovative ways.
To deliver services that met these payment models, several types of entities jumped into buying or investing in existing companies, Braff said.
More recently, perceptions that the Biden administration would raise capital gains taxes inspired many behavioral health sellers to hit the market in 2021. This coupled with what Braff called “optimism bias” raised by COVID-driven interest in behavioral health to send dealmaking volume to the moon.
“COVID made us all insane,” Braff said of the big jump in deal activity in behavioral health. “The expectations of the investment community, when COVID really put its hooks into the market, made them say, ‘We really need to get into this market; we knew it was good before.’”
Effectively, the public health emergency “jump-started” M&A “because more money was coming in and the need for services was definitely going to go up,” he continued.
The behavioral health sector saw back-to-back record-breaking M&A years in 2020 and 2021. The former saw 189 deals, a 5.6% year-over-year increase, while 2021 saw 256 deals, a 35% year-over-year increase, according to data generated by The Braff Group
Since then, the market has cooled off slightly. But again, it’s still “robust.”
“All you people that think you want to be investing in behavioral health, you’re in the right space,” Braff said. “But you’re going to have to pay up to get into it.”
Annualized based on the first two quarters of the year, The Braff Group estimates that 2022 will see a total of 204 deals, higher than any year pre-pandemic, continuing the strong year-over-year growth of dealmaking in the sector. Still, that would be a 20% year-over-year dip.
The firm is still working on Q3 numbers, Braff said.
The state of the M&A market
Private equity dollars drove most of the activity in investments and M&A in behavioral health over the last few years, Braff said. Perhaps the best example of that came in 2019 in the autism space – when every single transaction tracked by Braff was tied to PE.
But that activity will likely slow – at least somewhat – going forward
The increase in interest rates will likely constrain the amount of capital that PE firms will put out, partially because PE buyers often finance deals via a mix of equity and debt. Rather than increasing equity investment to make up for lower levels of debt, firms will more likely constrain equity dollars to match.
A report by McKinsey & Co. found that an average of 55% of private equity deal purchase prices were covered by debt in 2021.
Increasing interest rates can also make potential investors and sellers wary to make deals. David White, CEO of BayMark Health Services, a fast-growing addiction treatment provider, said at a separate INVEST panel that more deals are falling through now than in previous years.
“People are getting a little more risk averse,” White said. “I think people are worried about interest rates climbing, particularly if they have a lot of debt.”
Braff similarly said that while plenty of buyers are still poking around, looking for deals, fewer ultimately come to the table.
“There’s pressure pushing down on valuations. We haven’t seen that yet in actual deals,” Braff explained. “But here’s what we have seen: Where we might have previously gotten five offers in double digit multiples of EBITDA, we’re now getting two. So three people are dropping out.”
More on PE
Private equity firms will likely slow their roll on platform deals as uncertainty in the economy persists and deepens.
“When the economy is shaky, buyers like to make smaller bets,” Braff said. “It’s very, very common to see the value of deals drop and the volume of deals increase.”
Further complicating the environment for buyers? The frenzy of investment and buying in past years has driven up deal multiples to record highs – with sellers still looking to cash in despite the market changes. Record high acquisition multiples on EBITDA make it harder for investors to exit at a higher multiple in the future, Braff said.
All you people that think you want to be investing in behavioral health, you’re in the right space. But you’re going to have to pay up to get into it.
Dexter Braff, president of The Braff Group
He also pointed to tightening margins related to wage inflation and other workforce issues complicating deals. The country is in the midst of a workforce shortage in behavioral health, especially in the ranks of physician-level providers. Braff projects this will likely continue in the future.
However, the staffing problem has not limited the growth of some large, well-capitalized operators. Mindpath Health CEO Christopher Brengard said at an INVEST panel that the company has continued to grow but has to account for higher levels of turnover.
“All of us have a little bit of a retention issue,” Brengard said. “Therapists and psychiatrists are struggling every day to deal with the amount of business that is coming their way. … You’re constantly fighting that retention rate, [trying to] hire on top of it.”
Braff also said the market has largely shifted from actual 12-month trailing EBITDA to pro forma leading EBITDA measures, allowing for artificial inflation of a company’s value.
The forces of higher interest rates, cooling in the dealmaking space and economic uncertainty have not yet appeared in a major way in The Braff Group’s work, Braff said. However, there are signs that they are increasing in significance.
“The demand characteristics are working in your favor if you’re a seller,” he said. “But not so much if you’re a buyer.”
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