Substance Abuse Epidemic Augments M&A Wave: Will Investors Ever Sober to the Model?

For several years, private equity sponsors and strategic industry consolidators have aggressively targeted substance abuse treatment facilities. What is driving ongoing interest in the sector? Will these factors continue or are they showing signs of abatement?

Q2 Healthcare Graphic

Source: S&P Capital IQ, PitchBook, and various company press releases.

Large Population in Need

Today, an estimated 23 million Americans face some form of substance addiction. Opioids and alcohol are the two largest segments, accounting for over 68% of the affected population. Unfortunately, these two populations are seeing dramatic increases and unmet patient demand remains high, thereby creating an environment where the top treatment programs are juggling long waiting lists and the industry overall should experience a long runway of opportunity. The proportion of opiate admissions alone has increased from 18% in 2005 to 34% in 2015.

Highly Fragmented Market

The industry is highly fragmented with the nation’s two largest players accounting for only 8% market share. There are an estimated 28,600 treatment clinics operated by more than 19,200 enterprises, creating a long-term horizon for consolidation. Substantial opportunities exist to consolidate and leverage key corporate functions across a broader revenue base, while taking advantage of a broader marketing and patient intake funnel with more treatment programs and options available to incoming addicted individuals. Many operators have successfully grown by developing robust consumer marketing efforts and then building out the treatment capacity to treat a growing waitlist of patients.

Favorable Regulatory Tailwinds Driving Expanded Insurance Coverage

Coupled with the increasing number of affected individuals is the more comprehensive commercial insurance coverage environment available to fund treatment. Nearly 90% of mental health treatment facilities indicate that they currently accept Medicaid for services. The Mental Health Parity and Addiction Equity Act (MHPAEA) of 2008 and certain provisions in the Affordable Care Act (ACA) created dynamics whereby mental health and substance abuse insurance benefits must be offered to covered individuals and such benefits need to be in parity with other medical benefits. Furthermore, the latest federal health reform legislation contemplates expanding funding for opioid treatments in the future. Offsetting the growing covered population are challenges with insurance reimbursement levels and shorter lengths of approved treatment driving down revenue per patient.

Profitability of In-Network Reimbursement Models Continues to Evolve

Substance abuse treatment brings with it a multitude of payors including CMS, commercial insurance (including both in-network and out-of-network reimbursement), and private cash pay. Such diversity enables treatment providers to target a broad cross-section of the population and create programs that meet the needs of each payor population thereby mitigating risk and driving opportunities for growth. Due to the strong demand for treatment services from Medicare and in-network commercially insured patients, the most successful addiction programs are developing alternative lower-cost models that allow them to maintain strong profitability by offsetting lower revenue with higher volume.

Attractive Unit and Growth Economic

Unlike many other healthcare settings, substance abuse treatment offers lower initial capital requirements and facility startup costs, thereby generating a high return on investment. Such dynamics create compelling de novo growth opportunities, especially when combined with long patient waiting lists and in-network insurance referral volume.

As macro drivers continue to demonstrate primarily favorable tailwinds, we expect interest in the sector to remain strong, especially as new and innovative treatment models emerge to drive growth.