|UHS corporate headquarters in King of Prussia, Pa.|
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,
“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.
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:”
Strong industry outlook. First, he explained, “we believe that the behavioral health industry has a tremendous outlook. It's a fundamentally very sound industry. It has not been expanded or overbuilt the way a number of other healthcare services have, and I believe it is unlikely to be.” He added that after UHS facilities peaked out at 85 percent occupancy in 2005, UHS began expanding bed capacity, followed thereafter by PSI. That capacity is now online in time to realize the improved insurance coverage brought about by parity.
UHS operating experience. Second, he asserted that “the company we're buying is very similar to the company that we operate,” adding that “the portfolio that PSI operated is very similar to our business. It is run in a very similar way.” He credited PSI with aggressively building a large portfolio of assets in a fairly short period and noted that, in many cases, UHS became familiar with these assets as the two companies competed to acquire them. He argued that this knowledge, combined with UHS' skill set-specifically its experience in operating assets efficiently-would enable UHS to optimize returns from the acquisition.
#1 and #2 get together
Historically, said Filton, “We've tended to run operating margins that are 200 to 250 basis points better than PSI and we hope to bring that same leverage and benefit as well.” While Filton didn't offer specifics about how margins would be improved, Kemp Dolliver, a managing director with Avondale Partners (Boston, Mass.) pointed to four factors: “You're going to have a larger company run by essentially a single management team.… Over time, UHS facilities have run with a higher occupancy rate than PSI facilities … and UHS has tended to operate with a smaller regional staff than PSI.” Dolliver added that UHS could also leverage its acute care division for support with compliance, audit, tax, procurement and other necessary functions.
A lower public and investor profile. Third, alluding to well-publicized safety and quality concerns at several PSI facilities during 2008 that some attributed to that company's rapid growth, Filton said that UHS-operated facilities “have tended to have less of the quality and PR issues that PSI has had.”
1) Solid growth, based on high occupancy. Filton reported that “same store adjusted” admissions for UHS behavioral health facilities increased 4 percent through the first three quarters of 2010 and that PSI facility results for the same period were “a little stronger.” RBC's Morgan agrees. “Just look at the same store volume growth numbers for behavioral health and compare those to say, acute care, there's just no comparison. The growth rates, the volume of growth and the rate of growth in the behavioral health area is much better, with much lower levels of uncompensated care.”
Nationwide, the latest survey by the National Association of Psychiatric Health Systems (NAPHS) put the occupancy rate for inpatient psychiatric facilities at about 74 percent. When typical institutional and management factors are applied to that rate, it means that about nine out of 10 psychiatric beds are filled, says NAPHS CEO Mark Covall.
UHS Facility Divestitures3
2) Recession-resistant results. UHS' behavioral revenues outperformed its forecast of 3 to 4 percent due to a number of factors, said Filton, including the impact of parity regulations, capacity additions, and the fact that “behavioral health has been the most resistant to the recessionary dynamics of any area of care, even acute care.” Filton noted that in other segments of healthcare, consumers frequently delay care due to concerns about insurance coverage, out of pocket expenses, or concerns about job security. Not so with behavioral health, though.
“The ultimate decisions about care are often not made by the patients themselves,” he says, explaining that when a patient is admitted to care, someone else has determined the need for admission, such as a school or an acute care ER. “The decision is discrete from the finances involved.”
3) Low risk of uncompensated care. Because of the nature of inpatient behavioral admissions, the sector is also much less vulnerable to the risk of uncompensated care. By comparison, the level of uncompensated care/bad debt has risen dramatically for acute care in recent years-up to about 13 percent of revenue, said Filton. “It runs in our behavioral business at roughly 2.5, or about one-fifth the rate.”
4) Little competition. Relative to acute care hospitals, inpatient psychiatric hospitals and facilities enjoy another significant advantage. “We have faced tremendous competition from niche competitors in acute care-ambulatory surgery centers, imaging and radiation centers, physicians who do work that was once done only in hospitals,” said Filton, noting that “the behavioral division sees very little of that kind of competition from its physicians or other providers.” With the exception of similar, freestanding facilities or psychiatric units in acute care facilities, Filton stated that the inpatient business has, “in many respects, virtually no competitors.”
Could history repeat itself? Not likely.To longtime industry watchers, the rise of UHS as the industry's new giant seems vaguely similar to the emergence of NMS and Charter, the industry's first huge operators, both of whom collapsed. But that's about as close as the similarity gets, according to Mark Covall of NAPHS. While demand for inpatient psychiatric services is up due to a market shakeout that thinned the provider base by some 40 percent and finally bottomed out in 2004-2005, the market isn't nearly as attractive to newcomers as it was in the late 1980s. Why?
Payers are far more sophisticated, and cost-based reimbursement is gone for good. Two things have done it in, says Covall. On the public side, both Medicare and Medicaid have introduced “prospective payment systems” or PPS, which provide fixed payments (adjusted for patient acuity) that drive inpatient psychiatric facilities toward service efficiency. Private insurers have instituted rigorous care pre-certification, authorization and review practices, in part because of the fraud generated by a handful of psychiatric services providers in the late-1980s and into the 1990s. Overall payments are lower, in real dollars, than before, Covall adds, while “there's no way to get back to the longer stays and additional services of the past.” The difference between payers, then and now, “is night and day.”
Operating margins have tightened substantially. The trend toward consolidation, typified by the big UHS acquisition, is likely to continue as good operators seek to drive costs down and spread them over more facilities. “It used to be that you could make it at 40 percent occupancy,” Covall recalls, adding that “now the economics have greatly changed.” This makes it “very difficult to move into a market and open a hospital absent very strong demand.” Future overbuilding of psychiatric hospitals is unlikely, he concludes.
Psychiatric hospitals have entered healthcare's mainstream. The increased scrutiny, focus on quality, and drive to greater efficiency “shows that we're very much mainstream, like other hospital facilities,” says Covall. “When you see a company like UHS, who has built its reputation on acute care, come in and acquire behavioral health facilities, it says a lot about how closely the two areas have come together.” Soon, new measures will track inpatient psychiatric quality more closely than ever before, putting psychiatric hospital quality measures “on par” with those of acute care, says Covall. These Hospital Based Inpatient Psychiatric Services (HBIPS) measures, which were piloted at UHS, PSI, and other facilities around the country, become mandatory for all Joint Commission-accredited inpatient psychiatric hospitals and psychiatric care units in January 2011. Despite higher payer scrutiny, higher barriers to entry, and more challenging economics for NAPHS member organizations like UHS, Covall continues to see strong demand signals in the marketplace:
|Behavioral Healthcare wants to know.|
E-mail Dennis Grantham at email@example.com.
Behavioral Healthcare 2011 January-February;31(1):15-20