Risky business: The build-versus-buy crossroads for mental health companies

As economic headwinds make smaller mental health deals an attractive prospect in 2023, some larger players may choose to slow their overall M&A strategy in favor of de novos.

Tuck-in acquisitions take time, verification, and money. And in some cases, despite all this, transactions may fall short of the buyer’s expectations and never cross the finish line.

For operators looking to secure growth, de novos could cost less and speed up the process.

“A small deal requires just as much work as a big deal,” says Peter Nystrom.

Chief Commercial Officer at Nystrom & Associates, said during Behavioral Health Business’ INVEST event. “You see a lot of larger groups thinking, ‘Do I want to stay with this acquisition or pull back and focus on a de novo strategy?’ So acquisitions have to really make sense for our groups to make them.”

Founded in 1991, Nystrom & Associates is a behavioral health provider with offices in Minnesota, Iowa and Wisconsin.

Publicly traded companies in the behavioral health market have also recently been evaluating build-or-buy options. Indeed, behavioral health giant LifeStance Health Group Inc. (Nasdaq: LFST) is prioritizing organic growth in 2023 and more strategic mergers and acquisitions, Chairman and CEO Ken Burdick said during its third-quarter earnings call last week.

“We are intentionally moderating mergers and acquisitions as we continue our shift to organic growth,” Burdick said.

Additionally, at the end of the day, operators who choose to grow organically can end up in a pretty similar spot to those who acquired another company.

But a de novo will likely cost less, Nystrom said. If this trend becomes more prevalent, it could lower demand for smaller behavioral acquisitions in the future.

“I think there’s going to be less demand for a lot of these tuck-ins,” Nystrom said. “I think vendors will have come to realize that there will be multiple compression in the near future if it hasn’t already.”

According to a recent report by PitchBook, that compression has indeed begun — but not because of a shift in transaction activity. Rather, staffing challenges have tempered the overall outlook for the behavioral health market.

“In formerly red-hot categories like behavioral health, multiples could cool if growth slows due to staff shortages,” the report said.

Peter Nystrom,
Chief Commercial Officer at Nystrom & Associates, speaks during Behavioral Health Business’ INVEST event

risk management

Acquisitions also come with some risk — particularly given the record-breaking valuations of 2021.

“You really have to take care of that [your dealmaking team has] have exercised due diligence,” William Hartje, chief development officer at Refresh, told INVEST. “It could be painful when you pay such high prices for something that might turn out not to be what you expected. … So I would expect there to be some misses.”

Outpatient mental health provider Refresh Health has more than 300 locations in 37 states. Its services include treatment for substance use disorders (SUD), mental illness, eating disorders, couples therapy, psychiatry and more. In March, it was acquired by Optum, the healthcare services division of UnitedHealth Group (NYSE: UNH), for an undisclosed sum.

William Hartje, Chief Development Officer at Refresh, speaks at INVEST

Going through the M&A process is a bit like dating, Nystrom said.

It takes months to build the relationship, go through the legal process and complete the due diligence. That time doesn’t always pay off. But with the same amount of time and effort, a company could invest in marketing and recruitment to launch a de novo business or expand its presence in a market it has already entered.

“We see a fair drop off from the first interaction [the companies] who actually pull through,” said Gaurav Bhattacharyya, CEO of Geode Health, at INVEST. “Sometimes it’s because they just don’t want it. This is where the value of a broker-led process is valuable, because you know this seller is motivated to move forward.”

Founded in 2017 by global investment firm KKR, Chicago-based Geode Health provides in-person and virtual outpatient treatments nationwide.

Gaurav Bhattacharyya, CEO of Geode Health, speaks at INVEST

When a purchase makes sense

Strong M&A strategies can also make sense, for example as operators seek to accelerate expansion into new markets and capitalize on the established relationships of the assets they purchase.

“For de novos to be successful, you need market reputation, you need relationships with the referral ecosystem,” Bhattacharyya said.

It might be easier and more financially viable to acquire a vendor that already has those relationships, Bhattacharyya said. Since the seller’s reputation is vital, due diligence is paramount.

It’s important to start the review process early and spend time with a seller and their team to make sure it’s a good fit.

“We always like to get in front of the potential seller,” Nystorm said. “We’ll get to know them right away, rather than looking at a pipeline of names in a spreadsheet that says, ‘Okay, they look good on paper, but do they look good functionally?’ Are they personally good so you can really understand the quality of how they feel about the future [with the process]how long does the owner want people in the business?”

Despite the risks of mergers and acquisitions, the mental health market continues to offer plenty of opportunity and is unlikely to slow down significantly anytime soon.

“I think the nature of the market is that it’s extremely fragmented,” Bhattacharyya said. “And so I think the volume of deals, if any, could go up. But they will tend to be smaller, sort of true roll-up opportunities as opposed to big platforms, necessarily.”


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