If you're a behavioral healthcare provider that, in the midst of yet another difficult quarter, is asking, “Why can't I work in a hot growth business?” you need to take another look around. Why?
Because the $3.1 billion ($2 billion cash, $1.1 billion debt) acquisition of Psychiatric Solutions, Inc. (PSI) by Universal Health Services (UHS), announced in May 2010 and completed in November, has focused investor attention on what analysts see as the very attractive fundamentals for two key segments of behavioral healthcare: inpatient psychiatric hospitals and residential treatment centers. “From the perspective of Wall Street, investors in the behavioral health industry have, for some years now, seen a growth opportunity without some of the risks and challenges that are found in other healthcare sectors,” said Frank Morgan, CFA, a managing director with RBC Capital Markets (Brentwood, Tenn.)
Alan B. Miller,
Chairman and CEO
Senior Vice President, President, Behavioral Health Division
“They see more predictable volume growth, lower levels of uncompensated care, and the opportunity for superior free cash flow generation.” He says that investors also see an industry that has endured “a significant reduction in capacity” followed by a period in which “demand has been growing.” The acquisition of PSI closes an exciting decade of fast-paced growth that saw PSI grow into the nation's largest consolidator and operator of psychiatric facilities, with 94 locations, over 11,000 beds and a 19 percent market share. “They recognized the industry opportunity faster than anyone else and were first to begin consolidating toward becoming the largest player in the industry,” said Morgan. Just three years after launching its acquisition drive, PSI went public in August 2002, seeking capital to feed its continued acquisition effort.
But, PSI's unique success and market position had a downside as well, particularly when it faced safety and quality problems at facilities in Chicago, Philadelphia, and Reno in 2008 and 2009. “With such rapid growth, you can draw a lot of attention,” said Morgan. “At the time, they were the easiest target out there-the only pure play.”
As the negative publicity drove down PSI's share price and complicated the company's efforts to continue expanding, CEO Joey Jacobs reportedly led an effort to take the undervalued company private in early 2010 with a multi-billion-dollar leveraged buyout funded by private equity firm Bain Capital.
However, as investors got wind of the potential buyout, PSI's stock value jumped and other suitors, including Universal Health Services (King of Prussia, Pa.), entered the fray as hostile bidders. PSI's board of directors, seeking to maximize shareholder value, saw the benefits of UHS' $33.75 per share acquisition bid, which was ratified by PSI shareholders in the fall.
UHS makes third big behavioral buy
Just a year ago, UHS was known primarily as an experienced, tight-fisted, and profitable operator of acute care hospitals, where it generated 74 percent of its $5.2 billion in 2009 revenues. Yet, under longtime CEO Alan Miller, UHS had been pursuing its own plans for the behavioral health market, acquiring one or more psychiatric facilities in 12 of the past 15 years and building a behavioral health business with revenues of $1.25 billion in 2009, second only to PSI. And, twice before, UHS had bought big: in May 2000, it bought 11 psychiatric hospitals from once-dominant Charter Behavioral Health Systems following Charter's March 2000 bankruptcy filing.
Timeline for a turbulent industry
Then, it purchased 46 psychiatric facilities when it acquired the Keys Group in 2005. But the latest UHS acquisition dwarfed the others and promises to fundamentally reshape UHS.
Based on 2009 results, the company's roughly 75/25 revenue split between acute care and behavioral health will change to a more balanced 55/45. But, according to UHS CFO Steve Filton, the higher margins associated with inpatient psychiatric services, relative to acute care, mean that the behavioral health division could well deliver more pretax income to UHS than its larger divisional sibling.
The deal is backed with $4.15 billion in committed debt financing from JP Morgan and Deutsche Bank, making it one of the largest corporate acquisitions since the banking scare of 2009. Despite its daunting size, UHS' Filton asserted in an 4Q 2010 conference with investors that “the deal makes sense in three ways:”