Leveraging An American Epidemic

&l;p&g;&l;img class=&q;size-full wp-image-3134&q; src=&q;http://blogs-images.forbes.com/forbesfinancecouncil/files/2018/06/pexels-photo-267469-1.jpg?width=960&q; alt=&q;&q; data-height=&q;640&q; data-width=&q;960&q;&g; Pexels

At a time when the news cycle moves our economy like a high-pitched tuning fork, we have an opportunity, potential tragedy and an all-around need for &l;em&g;prolific&l;/em&g; problem solvers. The war on the opioid and addiction crisis is a timely bipartisan issue that makes headlines daily. Unfortunately, what is left out is the crumbling infrastructure of an industry that has been inflated, abused and infested with questionable to fraudulent activity, placing it on the edge of the proverbial cliff.

This is the summation of my seven years with a foot in the finance industry and the other in the healthcare providers sector.

My previous &l;a href=&q;https://www.forbes.com/sites/forbesfinancecouncil/2018/05/21/part-i-a-perfect-storm-how-mental-and-behavioral-health-care-became-a-financial-crisis&q;&g;article&l;/a&g; was published the day after John Oliver decided to &l;a href=&q;https://quartzy.qz.com/1283491/john-oliver-explains-why-the-american-rehab-industry-is-a-disaster-on-last-week-tonight/&q; target=&q;_blank&q;&g;roast&l;/a&g; the questionable and fraudulent industry ethics. Then, two days after the first piece of this series was published online, my prediction was partially validated with the &l;a href=&q;https://www.wsj.com/articles/elements-behavioral-health-files-for-bankruptcy-protection-1527131546&q; target=&q;_blank&q;&g;bankruptcy&l;/a&g; of Elements Behavioral Health Inc. Not long after, the media &l;a href=&q;https://www.10news.com/news/sovereign-health-employees-say-paychecks-are-weeks-late&q; target=&q;_blank&q;&g;highlighted&l;/a&g; the cash-flow &l;a href=&q;http://www.latimes.com/local/lanow/la-me-ln-sovereign-health-raid-20170613-story.html&q; target=&q;_blank&q;&g;woes&l;/a&g; of once-giant, Sovereign Health.

The previous article detailed how the 2008 Medicare Improvements for Patient Providers Act (MIPPA) and the updated Mental Health Parity and Addiction Equity Act (MHPAEA) turned mental health care reimbursements into a gravy train for investors and fraudsters. Mandating that behavioral and mental health (B&a;amp;MH) treatments be reimbursed on the same scale as surgical procedures quickly transformed it into the most lucrative space generating the best margins in the healthcare sector. Simply put, a fast-moving Congress, special interests and earmarks enabled some haphazard legislation. Once a genuine form of treatment and rehabilitation, drug treatment centers from California to Florida quickly became a cash cow for everyone involved except the most vulnerable party:&a;nbsp;&l;em&g;the patients.&l;/em&g;&a;nbsp;MIPPA and the Affordable Care Act (ACA) effectively turned B&a;amp;MH into the perfect space for fraudulent practices, including over-billing, patient brokering, kickbacks and exhaustion of lifetime benefits of clients.

The burgeoning personal and public costs of the opioid crisis, compounded by both &l;a href=&q;https://www.cnn.com/2017/09/19/health/state-ag-investigation-opioids-subpoenas/index.html&q; target=&q;_blank&q;&g;criminal and civil investigations&l;/a&g; into many treatment providers, highlight the operational risk of this investment. Unprecedented amounts of funding combined with lax oversight created a perfect storm for financial mismanagement of behavioral health treatment in the United States. It made risky lending accessible again for the first time since 2008, and the reason I believe it will collapse — and soon — is simple: supply and demand.

There&s;s an &l;a href=&q;https://www.investopedia.com/articles/investing/082515/how-do-asset-bubbles-cause-recessions.asp&q; target=&q;_blank&q;&g;asset bubble&l;/a&g;&a;nbsp;– but a shortage of quality care — in an oversaturated market with an ample supply of poor care. There are&l;em&g; two&l;/em&g; supply-and-demand factors: the consumer good (care) and the asset (treatment centers). Underwriters are providing loans to public companies based on private company valuation: a fundamental flaw. The private equity (PE) investment into the health care market is already seeing some &l;a href=&q;https://blogs.wsj.com/privateequity/2015/11/10/private-equitys-latest-obsession-add-on-deals-to-drive-down-cost/&q; target=&q;_blank&q;&g;bizarre activity&l;/a&g;, from an M&a;amp;A standpoint.

&l;strong&g;Timeline Of Irresponsible Finance In Behavioral Health&l;/strong&g;

&l;!–nextpage–&g; The key point here is to remember that hot markets are capitalized with &l;a href=&q;https://www.investopedia.com/terms/l/leveragedbuyout.asp&q; target=&q;_blank&q;&g;leveraged buyouts&l;/a&g; (LBOs), the staple of PE. They attempt to use as much debt as possible so the &l;a href=&q;https://www.investopedia.com/terms/c/carriedinterest.asp&q; target=&q;_blank&q;&g;carried interest&l;/a&g; is increased. The machine grinds forward if the growth rate exceeds the interest rates on the debt. Keep in mind, the entity being acquired nearly always holds the note. Traditionally, this was done so that the target companies being acquired could easily be jettisoned. That could be changing&a;nbsp;&l;a href=&q;http://www.pionline.com/article/20160502/PRINT/305029976/sun-capital-case-may-tip-private-equity-equation&q; target=&q;_blank&q;&g;for the worse.&l;/a&g;

The &l;a href=&q;https://www.samhsa.gov/health-financing/implementation-mental-health-parity-addiction-equity-act&q; target=&q;_blank&q;&g;MHPAEA (parity)&l;/a&g; entered effect in November 2009. People remained aloof to this law&a;rsquo;s existence through the ACA vote in Congress. By 2010, &a;nbsp;treatment center owners had discovered the ease of &l;a href=&q;http://www.latimes.com/opinion/opinion-la/la-ol-out-of-network-doctor-bills-surprise-new-york-times-20140922-story.html&q; target=&q;_blank&q;&g;abusing the new out-of-network benefits&l;/a&g;, essentially billing whatever they wanted and getting paid. By 2011, the &l;a href=&q;https://www.bloomberg.com/news/articles/2017-03-30/private-equity-rehab-romance-rages-amid-health-law-turmoil&q; target=&q;_blank&q;&g;LBO-Boom&l;/a&g;&a;nbsp;had awoken from its 2008-triggered hibernation.

In fact, by 2011, the drug treatment sector underwent a paradigm shift, if not a complete 180-degree turn. &l;a href=&q;https://www.advisory.com/Daily-Briefing/2012/01/26/Merger-and-acquisition-activity&q; target=&q;_blank&q;&g;Health care deals&l;/a&g; numbered 980, surging over 9% year-over-year. The B&a;amp;MH sector was thrust into the world of five-star hotels, extravagant conference halls with equally overt booths serving gourmet cupcakes while hustling urine-tests. The urine-tests were the &l;a href=&q;https://www.nytimes.com/interactive/2017/12/27/business/urine-test-cost.html?mtrref=www.google.com&a;amp;gwh=29B6AB35347137F08DEC4031C5BB343F&a;amp;gwt=pay&q; target=&q;_blank&q;&g;notable discrepancy&l;/a&g;, susceptible to fraudulent billing, duping investors into believing they were legitimate regulated medical services.

In 2015, American Addiction Centers (AAC) was &l;a href=&q;https://blogs.wsj.com/moneybeat/2015/08/05/blog-post-from-college-student-causes-massive-sell-off-in-aac-holdings/&q; target=&q;_blank&q;&g;exposed&l;/a&g; by then-Furman University senior Chris Drose for withholding information to investors regarding a California &l;a href=&q;https://www.forbes.com/sites/nathanvardi/2015/07/31/the-company-and-corporate-president-indicted-for-murder/#291eb847230d&q;&g;indictment of a company executive&l;/a&g; for the case of murder and excessive billing for urine-based drug tests. The industry has been on life support since August 2015. The health care world corrected, but it was the PE deals that continued to keep the public players alive.

Now, in 2018, PE firms &l;em&g;aren&a;rsquo;t making carried interest&l;/em&g; unless they&a;rsquo;re exiting/selling. However, the ice is melting up on general health care sector consolidation fever. The LBO-laden sector began with the first place it used the risky loans since 2008: mental health care. It would make sense, given the effects of AAC and the timeline, that the epicenter of a health care crash could be at its very end. The panicked M&a;amp;A behavior is strikingly like 2008.

&l;/p&g;&l;h4&g;&l;strong&g;Where are we now? &l;/strong&g;&l;/h4&g;

Valuations of these assets have always been centric to the purchaser. Like many LBO scenarios, they bask in the unseen nature of &l;em&g;private &l;/em&g;equity. The high amount of leverage used has led to this melt-up. These valuations peak at over 30 times earnings in some cases. Nearly every major U.S. and European bank participates in &l;a href=&q;https://www.thebalance.com/tranches-definition-risks-and-how-they-work-3305901&q; target=&q;_blank&q;&g;securitization tranches&l;/a&g; for large commercial loans, exemplifying the absence of competition in commercial lending.

&q;Unitranche&q; is a word that doesn&a;rsquo;t autocorrect in a common spellchecker. However, Capital One has a whole division for it. These loans in health care are destined, in my mind, to be the&a;nbsp;10-years younger cousin of the &l;a href=&q;https://www.investopedia.com/terms/s/syntheticcdo.asp&q; target=&q;_blank&q;&g;synthetic CDO.&l;/a&g;&a;nbsp;The synthetic CDO was the last artifact of the 2008 chase for high yielding investments. Unitranche loans combine highly levered senior and subordinate debt and &l;a href=&q;https://media2.mofo.com/documents/160800unitranchefinancing.pdf&q; target=&q;_blank&q;&g;don&a;rsquo;t offer any protections&l;/a&g;&a;nbsp;– nor have they been tested in U.S. Bankruptcy Court.

It&a;rsquo;s only a matter of time until one of the debt-laden public providers ends up in bankruptcy court. We could be primed for a challenging unraveling. This potential 2018-2019 financial crisis reveals questionable motives and fraudulent activities exacerbating the crumbling state of the B&a;amp;MH industry.

Who created it? A potent legislative cocktail I watched begin while I was in treatment myself a decade ago.

&l;!–nextpage–&g; How do we fix it? Use private wealth to right the ship. We can still de-escalate it to some degree.

What will prove insurmountable? Health care &l;a href=&q;https://www.investopedia.com/terms/s/supplyshock.asp&q; target=&q;_blank&q;&g;supply shock.&l;/a&g;

With out-of-pocket maximums and deductibles soaring, it&a;rsquo;s going to be a truly interesting day when folks realize what a &a;ldquo;subsidy&a;rdquo; is. This is bound to happen at some point. The fraud still occurs, and it&a;rsquo;s too much to ignore.


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