Q1 2015 BEHAVIORAL HEALTHCARE SERVIC Behavioral...  GROWTH DRIVERS (Continued)...

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    2010 2011 2012 2013 2014

    BOSTON

    CHICAGO

    LONDON

    LOS ANGELES

    PHILADELPHIA

    SAN DIEGO

    SILICON VALLEY

    TAMPA

    MERGER & ACQUISITION ACTIVITY: 2014 YEAR IN REVIEW

    The behavioral healthcare industry has seen a trend of consolidation in recent years, which

    continued through 2014. This past year, the industry peaked at 41 M&A transactions, fueled by

    rising valuations, industry consolidation and positive industry dynamics. More specifically,

    increased access to healthcare coverage has driven demand for behavioral healthcare services to

    outpace supply, pushing new investors who are anticipating continued growth into the market.

    Active strategic interest in the space has been the main driver of both transaction volume and

    valuation as providers look to expand into different geographies, diversify their program offerings

    and increase their market share. Most of the roughly 14,500 drug treatment facilities in the

    United States are small, with the average operator holding only one or two facilities. Even the

    largest operators do not own more than several dozen treatment centers. Providers seek margin

    growth through economies of scale and are using acquisitions of established regional facilities as

    the solution. In addition, public facilities are facing budget cuts, causing a move towards

    additional privatization of the behavioral health services sector and demand is high for private

    providers in key geographic markets.

    The small size of most operators and rising transaction multiples have in some instances

    mitigated private equitys otherwise healthy appetite for this sector. Acadia Healthcares Q4

    2014 acquisition of CRC Health, for example, valued the company at more than ten times

    earnings. Overall, though, private equity remains interested as reduced reimbursement risk, a

    historically underserved market and privatization leave the sector ripe for consolidation. As an

    example, Goldman Sachs recently funded platform company Advanced Recovery Systems to

    acquire and develop rehabilitation clinics.

    CONTACTS John Ferrara Founder & President (617) 619-3325 jferrara@capstonellc.com Sophea Chau Director (617) 619-3307 schau@capstonellc.com Matthew Person Associate (617) 619-3322 mperson@capstonellc.com

    Q1 2015

    M&A Activity: Behavioral Healthcare

    Source: Capital IQ; Capstone Partners LLC Research

    BEHAVIORAL HEALTHCARE SERVICES

  • 2015 OUTLOOK

    Even with the increase in transaction volume in 2014, behavioral health companies

    spent much of the year navigating the changes resulting from the Affordable Care Act

    (ACA) that went into effect. Many operators were on pause, waiting to see how the

    ACA and other healthcare regulations would impact healthcare exchanges and

    reimbursement. With that hurdle now behind the industry, providers are once again

    moving ahead and focusing on growth. Moreover, the increased acceptance of

    mental health and substance abuse treatment is expected to drive industry growth.

    One trend in delivering behavioral healthcare is the growing awareness of gender-

    specific issues. Studies show that psychiatric disorders often develop prior to

    substance abuse in women. As such, about 40% of substance abuse facilities now

    offer specific programs for women. Generalist behavioral healthcare providers are

    looking to acquire gender-specific specialists to meet this growing mode of

    treatment.

    Given the industrys significant long-term growth opportunities and highly

    fragmented nature (i.e., of the 14,000+ facilities in the U.S., the top 50 providers

    control less than 20% of the market), transaction volume is expected to continue to

    rise in 2015 and beyond. Middle market deals will drive M&A activity as many of the

    larger providers have been acquired over the last few years. Industry veteran

    Universal Health Systems, for example, has made four behavioral health related

    acquisitions in the last few years, including the $335 million purchase of Cygnet

    Health Care Limited in 2014 and the $500 million acquisition of Ascend Health

    Corporation in 2012.

    AMERICAN ADDICTION CENTERS

    In a market typically comprised of smaller organizations and non-profits, American

    Addiction Centers (NYSE:AAC) October 2014 initial public offering is a significant

    move for the sector as a sign of the growing demand for behavioral health services

    and the viability of a for-profit delivery model. In addition, AAC becomes the second

    pure-play publicly traded company in this space (other than Acadia Healthcare

    Company).

    Founded in 2007, the Brentwood, Tennessee based company operates six substance

    abuse treatment facilities in California, Florida, Nevada and Texas and an obesity-

    related treatment facility in Tennessee. AAC has emerged as one of the largest

    substance abuse treatment providers in the U.S. and has grown rapidly since 2010

    from $11 million in sales to more than $115 million in 2013, an impressive growth

    trajectory. In its IPO, AAC priced 5 million shares of common stock at $15 per share.

    Shares closed at $18.60 on the first day of trading, a 24% increase, and were trading

    at $30.13 as of the close of trading on January 16th.

    Capstone Partners LLC 2

    Behavioral Healthcare Q1 2015

  • GROWTH DRIVERS

    The long term prospects for behavioral healthcare appear both bright and

    sustainable due to several important dynamics. We have identified some of the key

    growth drivers below.

    Relatively Low Market Penetration Many people who have a mental illness or

    drug/substance abuse problem are not being treated. It was estimated in 2012 by

    the Substance Abuse and Mental Health Service Administration (SAMHSA) that only

    65% of adults with a serious impairment received treatment, and only a third of

    adults with mental illness or substance abuse problems receive minimally adequate

    treatment. Of those who elect not to be treated, almost three quarters of them feel

    that they do not want to handle the problem on their own, while less than 25%

    indicate that they do not have enough money to receive treatment. This implies that

    one of the biggest obstacles to market progress is the convenience and accessibility

    of the treatment centers, rather than the cost of receiving help. Hence, as mental

    illness and drug abuse become more widely recognized and diagnosed, increased

    accessibility to and convenience of health clinics that address these issues will further

    spur growth in the industry.

    Increases in Government Spending Medicaid and Medicare currently account for

    approximately 40-60% of revenue in the mental health and drug abuse services

    industry. The Affordable Care Act (ACA) passed in 2010 extended Medicaid coverage

    to a larger pool of applicants, thereby boosting demand for behavioral healthcare

    services. Approximately 45 million Americans still lack healthcare coverage, leaving

    an estimated 30% of people who ail from mental illness or drug abuse without

    coverage. According to IBISWorld, federal funding for Medicare and Medicaid is

    expected to grow at an average pace of between four and eight percent between

    2012-2018. In 2010, the White House implemented the 2008 interim rules of the

    Mental Health Parity and Addiction Equity Act (MHPAEA). The act requires group

    health plans and health insurance issuers to ensure that cost and treatment

    limitations associated with substance use disorder coverage are no more restrictive

    than limitations applied to all medical/surgical benefits. Both the ACA and MHPAEA

    increase affordability of and therefore boost demand for behavioral healthcare

    services.

    Growth in Private Insurance Due to healthcare reforms, the number of people who

    are covered by private insurance is expected to increase significantly in the next five

    years. In addition, federal subsidies will make private health insurance more

    affordable. Since those covered by private health insurance are likely to use

    healthcare services more frequently than they would otherwise, this trend of

    increased coverage is expected to increase demand for behavioral healthcare

    services. In 2013, approximately 11.3% of industry revenue was generated by private

    insurance.

    Capstone Partners LLC 3

    Behavioral Healthcare Q1 2015

  • GROWTH DRIVERS (Continued)

    De-Stigmatization of Receiving Help There has been a cultural de-stigmatization of

    seeking help for those suffering from mental illness or drug abuse. As stated, more

    than 75% of people who suffer from some form of mental illness or drug abuse avoid

    treatment for reasons other than monetary cost. Reasons vary amongst individuals,

    but primarily include one or more of the following: there is a negative stigma

    attached to mental health and drug abuse facilities, receiving treatment is too great

    of a task for one to accomplish on his or her own, and individuals feel that they do

    not in fact need help. Programs like the ACA and MHPAEA promote the idea that

    receiving treatment should be an affordable and culturally supported source