Falling Valuations, Less Competition Make Behavioral Health Deals ‘More Attractive’ to Investors

Despite the sky-high interest rates, this could be the prime time for behavioral health acquisitions. 

The demand for services remains high and the elevated interest rates mean that valuations are coming back down to earth. While de novo growth strategies have dominated the behavioral health domain in 2023, some investors see this moment as an opportunity to get back into M&A.

“In a couple of the categories where we have invested, M&A has become more attractive, not less,” Amy Christensen, a partner and co-head of healthcare at The Vistria Group, said at Behavioral Health Business’ INVEST. “What’s happened is that in specific parts of behavioral health, you have large competitors who have gone silent because they are upside down on the balance sheet.”

The Vistria Group is a private equity firm based in New York. Its portfolio has several behavioral health companies, including Sevita, Sandstone Care, Behavioral Health Group and Beacon Specialized Living.

“Then you have smaller companies that are upside down on the labor dynamics and to some extent on the reimbursement dynamics,” Christensen said. “It’s creating this interesting buying opportunity where multiples are actually at a reasonable price and you don’t have a lot of competition for deals.”

Overall, investors are seeing lower valuations, which could mean this is a good time to play on the offense for well-capitalized companies.

“There were some deals that were structured in 2021 that haven’t gone as well as planned, but the need for those services is evident,” Christian Chauvet, a partner at Lee Equity, said at INVEST. “We believe that there is a strong business model, and we think that there will be successful investments and some consolidation of that sector in the next couple of years, even though there have been bumps in the road.”

Middle-market PE firm Lee Equity is a veteran in the behavioral health space. In 2022, it purchased substance use disorder provider Bradford Health. It previously invested in the Eating Recovery Center and Summit BHC.

Those bumps in the road include several high-profile behavioral health companies collapsing in 2023. For example, the Center for Autism and Related Disorders (CARD) filed for bankruptcy earlier this year, just five years after PE firm Blackstone (NYSE:BX) invested $700 million for a 70% stake in the company.

But the market has changed quite a bit since this deal. While next year might be a good time for well-capitalized organizations to buy, it will likely be with more due diligence.

“We do have a higher threshold for acquisitions given the cost of the financing,” Chauvet said. “When you’re borrowing 11 or 12% a year, you really have to be diligent.”

Overall, diligence processes are taking longer. This can lead to some seller fatigue or other issues popping up, according to Tani Weiner, co-chair of behavioral health law group Polsinelli. He notes that it’s important for both the seller and the buyer to be flexible during this period. 

“I think buyers are becoming a lot more selective and discerning about wanting assets of quality,” Weiner said. “[Buyers] want to make sure what they are acquiring and have the assurance that it will be sustainable and prove out on the other side.” 

Polsinelli is a national law firm specializing in health care, real estate, finance, tech, PE and corporate transactions.

Still, there is a lot of white space in the behavioral health industry, which could help drive more consolidation and organic growth.

“What I see ahead in 2024 is a lot of demand for services and investment interest,” Weiner said. “I think you’re going to see growth across the board. For some providers, de novo is the answer; for others, it is continued add-on acquisitions. It’s been a slow year for platform sales, but I think we’re going to see more platform sales next year.”

And while the market could be ripe for smaller investments, many investors are still looking to grow their assets organically. Acquisitions will be few and far between and vetted more thoroughly than in the M&A craze of 2021 and 2022.

“We’ve probably been less active on the M&A front recently, partly coming back to the cost of capital and the models and teams we have in place at Nystrom and Pyramid,” Keith Farrow, managing director of Nautic Partners, said. “We have great organic capabilities and great de novo models. We’ve used M&A more selectively to accelerate our organic growth and enter a new market… So we’ve been more selective on how we approach M&A.”

Nautic Partners is a middle-market private equity firm based in Rhode Island. Its investments include Nystrom & Associates, Odyssey Behavioral Healthcare and Pyramid Healthcare Holding Company.

Deal tailwinds

Although the last few years saw a massive uptick in behavioral health deals, many mom-and-pop providers are still out there. Consolidation and investment could help the industry scale and professionalize.

“Behavioral health continues to be a sector where there are too few providers of scale and quality to really meet the need and partner with payers,” Chauvet said. “We’ve all been living through the parity arc, and we think that arc is still yet to be completed. There’s a lot of opportunity to professionalize behavioral health organizations and invest in outcomes tracking to really build world-class clinical organizations.”

Reimbursement trends are another reason investors are eyeing the behavioral health space for growth. While reimbursement rates are still lower than what many providers are looking for, payers are zeroing in on their behavioral health efforts.

“If we look at reimbursement in behavioral health compared to other parts of health services, it’s still pretty nascent. It’s developing. It’s modifying and changing,” Christensen said. “We overall expect that reimbursement should stay stable or improve.”

Christensen also noted that because the reimbursement environment has improved in behavioral health, this will help the industry build out some infrastructure layers that were previously cost-prohibitive.

The demand and the evolving reimbursement structure mean that many organizations look at behavioral health as a long-term investment.

“One thing we always look for is models that, when executed well, benefit the system. You often see how payers respond to them and are reimbursing for the services,” Farrow said. “We think the tailwinds are strong when you have the right team with the right clinical models. For us it’s a 20-plus year growth trend and those are the trends we like to be investing in.”