Only 20% to 25% of patients that need behavioral health support actually receive care. That means the behavioral health sector offers opportunity and high ROI for investors focused on delivering better outcomes at lower costs. 

Terry Wang, Partner at Regal Healthcare Capital Partners, joins host Geoff Cockrell on this episode of The Capital Corner for a discussion on how investors should view opportunities in the behavioral health sector, growth strategies, and what 2023 may look like.

“The most important element here is who is delivering care, really making sure that you're delivering care in a compliant way, in a quality way,” advises Terry. “Even if it may cost more in the short term, it's going to pay off in the long term. There are countless examples of behavioral health companies that have gotten in trouble because they've cut corners.” 

Even with the potential for difficult valuations in the current economic climate, Terry predicts lots of opportunity within the behavioral health sector. Once considered “the ugly stepchild” of the healthcare industry, it is now a primary focus for government agencies, healthcare providers, and patients, who are beginning to understand how mental health concerns can impact physical health. 

The sector is only just starting to mature, says Terry. Investors that can prove they can deliver better results at a lower cost stand to benefit from the enormous opportunity. 

Featured Guest

Name: Terry Wang

What he does: Terry is a Partner at Regal Healthcare Capital Partners. Before that, he was the VP of Operations at CHE Senior Psychological Services, a leading, private-equity backed provider of mental health services to skilled nursing, assisted living, adult day care, and rehab centers. He received a B.S. in Finance and Management from the Wharton School of the University of Pennsylvania, and an MBA from Harvard Business School. 

Organization: Regal Healthcare Capital Partners

Connect: LinkedIn

Notes From the Capital Corner

Top takeaways from this episode

★     Focus on delivering better outcomes at lower cost. According to Terry, there are opportunities to invest across the entire acuity spectrum of the behavioral health sector.

★     An underserved market leaves room for organic growth. With behavioral health needs being largely underserved, there’s an opportunity to hire and retain providers, contract with insurance companies, and find ways to market to new patients.  

★     Behavioral health assets can have different lifecycle opportunities. Platforms in the sector can progress through different stages as their size and scale changes. Early stage investors can get involved even when platforms are pre-revenue.

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This podcast was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this podcast, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information, or opinions expressed during this podcast series are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.

This is The Capital Corner, a McGuireWoods podcast, exploring investment strategies, capital structures and topics relevant in today's middle market private equity. Join McGuireWoods partner, Geoff Cockrell, as he and specialists share practical insights to inform your deal work.

Thank you for joining another episode of our Corner series. I'm your host, Geoff Cockrell, partner at McGuireWoods and chair of our private equity industry group where I spend almost all my time in healthcare investing.

In our Corner series, we bring together deal makers and specialists at the intersection of private equity investing in healthcare and explore sectors, trends, and the components of what makes those deals work.

Today I'm thrilled to be joined by Terry Wang, a partner at Regal Healthcare Partners, where Terry does investing in behavioral health and related fields. But Terry, maybe give a brief introduction of yourself and Regal Healthcare Partners before we get started.

Sure. Thanks, Jeff. Appreciate the chance to join you today.

Hey everyone, I'm Terry. I'm a partner at Regal. We focus on healthcare services and are currently investing out of our third fund, which is $415 million of committed capital. As Jeff mentioned, I look after three of our four behavioral health assets. We have autism company based out of Long Island that works with the school districts and works with children with autism and special needs. We have a mental health counseling company called Thriveworks, which is outpatient, low acuity mental health counseling, has about 300 locations across 40 states. We have a mental health crisis center down in Arizona that takes care of patients with serious mental illness. And we have a residential treatment center, intensive outpatient play out in California. So those are our four mental health assets here at Regal.

Perfect. Maybe to get started, Terry, it'd be great to get your perspective on how to think about segmenting the behavioral health sector. It covers such a wide array of sometimes disparate types of businesses. How do you think about segmenting the sector?

Sure. So I think there's a couple ways to look at it. At the highest level, you can divide it between payers and providers. And so on the payer side of behavioral health, you have the traditional insurance companies. You have what we call carveouts, so companies like Beacon or Magellan where insurance companies have outsourced behavioral health case management networks to them. And I think increasingly, you're seeing payers express interest in offloading risk and direct management of these behavioral health cases down to the providers. So you've got the payer side.

And then on the provider side, which I'll spend more of my time on, there's a couple ways to segment it. One is along the acuity spectrum. So you have high acuity behavioral health patients. These are patients that are costing the system a lot of money. They're oftentimes in and out of the emergency department, going through inpatient behavioral health facilities. They can easily rack up $20, $30, $40,000 a year spend just on behavioral health alone, and a similar amount on the medical spend side.

You've got medium acuity, and these patients are typically seen in intensive outpatient therapy programs.

And you've got low acuity. And low acuity represents 20% of the American population. These are patients that typically require some form of therapy or medication management for their mental health condition, but they're not in a residential setting. They're not in an inpatient setting. So that's one way to segment the market.

The other way is by diagnosis. So when we talk about behavioral health, you have general mental health issues, anxiety, depression, schizophrenia. You've got addiction related issues, and that could be alcohol, that could be drugs, that could be opioids. You've got more specialized behavioral health conditions like autism or eating disorders. And so when you look at it by diagnosis, each of those diagnoses also extend across that spectrum of severity I mentioned earlier. So you can have a patient with addiction issues that are more on the outpatient side, and then if they get more severe, it's going to be more on the high acuity side.

As you look at the sector across the ways that you've segmented it, what is your investment thesis, and are there certain parts of that grid that you think are more compelling and certain parts that are maybe less compelling?

For us, we actually invest across the entire acuity spectrum, high acuity, medium acuity, low acuity. There's a need across all those spectrums. For us, the key investment criteria is, are we able to deliver better outcomes at lower cost? And so when we look at different care delivery models, outpatient is very interesting. You're taking care of patients in a less restrictive environment. It's less expensive to payers, and if you can treat these conditions earlier on in a less restrictive setting, you can prevent them from getting into the higher acuity side.

At the same time though, on the higher acuity side, there are models where you can predict which patients are more likely to become high acuity. And so if you can focus on reducing the length of stay for these patients, making sure that they have access to social workers and other resources, that they're not constantly being readmitted into the emergency department or into behavioral health hospital, that's a huge value add to the system.

And growth strategies in these sectors. Are they more acquisition-oriented, de novo growth? There might be different answers to some of these different quadrants.

Yeah, seen both, and we've actually employed both of those strategies with our companies. By and large, behavioral health is a very fragmented industry. There's still a lot of mom and pops out there. And so from an acquisition perspective, there are opportunities to acquire smaller players, smaller providers, build a platform. I'd say it's harder now than it was a few years ago because there's been more interest and attention in the space from investors.

And then on the organic growth side, behavioral health is an industry that's growing fast. The need is enormous, and it's growing every day. Only 20%, 25% of patients that need behavioral health are actually getting it. So there's a lot of really compelling tailwinds behind behavioral health that make organic growth possible. When I say organic growth, this involves opening up new sites. Most importantly, this involves hiring and retaining providers, contracting with insurance companies, finding ways to market to patients or to referring providers. So organic growth does take a little longer, but if you have the right model, and you can grow organically, the return on investment is higher than going out and doing acquisitions. And the benefit of organic growth is you can maintain similar systems, culture. So there could be a lot of benefits to organic growth.

While there are some tailwinds on this sector with unfortunate demand, but also an evolving paired obligations with commercial payers, there's certainly some headwinds as well. What would you describe as some of the headwinds? And your answer may be staffing, staffing and staffing, but what are some of the headwinds that you encounter?

Sure. So I'd say there's two big ones. One relates to provider recruitment and retention, and the second relates to measuring outcomes and showing how and why you're differentiated in behavioral health. So I'll talk about the first one, which is provider recruitment and retention. There's about 700,000 licensed mental health clinicians in the US. These are psychologists, psychiatrists, behavioral health nurse practitioners, licensed counselors, licensed social workers. So it's a big field, but it's not enough. And the reason why is because the need for behavioral health is just so enormous. And so every organization you talk to that works in behavioral health, one of their, if not their top priority, is making sure that they've got a great organizational culture to retain clinicians and also a recruiting engine to be able to recruit providers and replace the ones that have left but also grow organically.

And I think one of the challenges around recruitment retention is the licensure side. For example, in many states, even if you're a licensed counselor, licensed social worker, you have a master's degree, it could take 2000 hours of supervision before you become fully licensed. And so there's a bottleneck from a licensure perspective. I think there is more attention and scrutiny now in behavioral health. And so we are starting to see more and more supply coming in, but it's nowhere near the demand.

On the second part around measuring outcomes, behavioral health has really lagged behind, historically, other areas of healthcare. Some of the ways to measure outcomes are based on self-assessment. Example, the PHQ-9, and so it can be a little fuzzy. I think the gold standard for measuring outcomes is to be able to take a given population that you're providing behavioral health services to and say, hey, we're able to deliver care at a lower cost, and that cost affects and saves money on medical costs as well, and we're able to achieve better outcomes, whether that's lower readmissions, and therefore what we're delivering makes sense. And I think we're still pretty far from being able to prove that out. There's still a lot of complexity to work through.

But for payers, they recognize the need for behavioral health. They're struggling in terms of differentiating who's good and who's not. So right now they're focused more on access. Are you able to deliver care quickly to my patients? But they're starting to now ask questions around outcomes, and that's going to be the key differentiator of a good behavioral health company versus one that's not great.

And are you left to your own devices on that as far as how you navigate measuring performance? Or is the industry coalescing around different ways of looking at that in a more standardized way?

The industry's starting to coalesce. It's still very early though. Like I mentioned earlier, there are some standard measurement metrics like a PHQ-9. But at the end of the day, what payers really care about in terms of costs versus tangible, quantifiable outcomes, we're still early stages there. And a lot of times it's up to a given provider group and a given payer to negotiate and work out a set of metrics or a measurement methodology that makes sense for both parties. And so in that sense, it's not really scalable.

Shifting gears a little bit, in thinking about the progression of platforms from initial platform size and scale, there's usually a transaction or two, often private equity to private equity and then some complex conversations about what the end game for those investments look like. First, where would you put Regal Healthcare Partners in that progression and in some maybe at different places and different things? And then I'm curious what your thoughts on the end game, bigger purchaser transactions, what you think the future looks like for those? Does everyone ultimately sell to Optum, like Kelso just sold one of their big platforms to Optum? Who are the backend buyers of some of these at scale?

Sure. So to your first question, Regal plays on the earlier stage of the platform evolution. And so our autism company, for example, it was doing revenue in the $10 to $30 million range when we started, but we can also start companies from scratch. So if we come across an interesting idea that we like, where you're not able to buy something of any scale, we'll start it from scratch.

In terms of the evolution of these companies, typically they grow, as we mentioned earlier, through a mix of organic growth or acquisitions. They get to a certain size, and a larger private equity firm comes in, acquires it, and it continues to grow from there.

To your question on who the end buyer is, Optum has obviously been active, but you do have other strategics. And interestingly, you have other health insurance companies as well that I think are eyeing behavioral health assets. Anthem for example, now they're called Elevance, acquired Beacon, which is a behavioral health payer carveout. And I think more and more health insurance companies are realizing that if they want to make sure their members have a good behavioral health experience, and if they want to control behavioral health spend and make sure that behavioral health can actually impact medical spend as well, that they need to own some aspect of the provider value chain.

And I do think that there are also examples of behavioral health companies that have gone public, Acadia, Universal Health, LifeStance. So I think there are different ways the end game can play out, and it's really going to be dependent on the state of the buyers, the market, and also the quality of the platform in the end.

Maybe talking a little bit about the market, obviously, behavioral health investing is impacted by things happening at a macro level as interest rates grow up. Syndicated debt markets have become more challenging. Valuations for healthcare companies have been relatively steady. What do you think the market for 2023 looks like in behavioral health from a valuation perspective and also from a deal volume perspective?

I think it'll be challenging on both fronts, especially for larger companies. So if you look at some of the publicly traded behavioral health names, they've struggled on the public markets. And I think it's a function of, not because the market demand isn't there, I think it's a function of when times were good, and investors got aggressive and properly overly excited, and the pendulum has swung hard the other way. But I think the fundamentals for behavioral health are still there. It's a large industry. It's growing. It's fragmented. There's a lot of opportunity to deliver better care at lower cost. So I think in the long run the fundamentals will catch up, but I think we're in for a rocky couple years, especially for the larger assets.

And on the smaller end where you're investing and putting together platforms, how do you think valuations in that part of the market in 2023 and 2024 will compare to the multiples that we saw in '21, '22?

Yeah, I think it'll be affected. Impacted, not as much. But at the same time, I think on the smaller end, you didn't see a huge run up in valuations the same way you did on some of the larger names. And especially for some of the smaller assets we're doing where we're not reliant on debt to acquire it, you're not going to see as big of an impact.

Well, Terry, as we wrap this up, any closing thoughts on the broader behavioral health sector?

I think on my end, what I would say is the key takeaways to leave from this is, this is a massive industry. There's tremendous need for it. I think if we're all honest with ourselves, we've got family and friends that have either benefited from behavioral health or would benefit from it.

I would also say that it's an industry where a lot of stakeholders are really paying attention to it now. It used to be the ugly stepchild for healthcare, but now it's front and center for payers, for government, for other healthcare, for providers, for patients. The stigma to get behavioral health has come down a lot. There is growing evidence that behavioral health directly impacts our physical health. So if you don't have access to behavioral health, your health outcomes in general are going to be more costly and worse.

And lastly, as we mentioned earlier, I think as a result of all this, there's still going to be a lot of interest from investors, from buyers, whether they are strategics or private equity or growth equity in this space. And even if valuations are challenging for a couple, for some of the larger assets, when you take a longer term view on this space, a 10, 20 year view, just have to recognize that we're still very early innings. We're probably inning number two of a nine inning game here with behavioral health.

Agreed. And I think you all sit at the perfect spot in the life cycle of these investments. There's in every market, even challenging ones for the larger acquisitions, there's a continuous demand for putting together the smaller platforms and growing them to a certain size. So I think where you sit will be less impacted by some of those macro headwinds. So you're definitely in the right spot.

Absolutely. And maybe the last thing I'd say is the most important element here is who is delivering care, really making sure that you're delivering care in a compliant way, in a quality way. And even if it may cost more in the short term, it's going to pay off in the long term.

There are countless examples of behavioral health companies that have gotten in trouble because they've cut corners. And so, look, at the end of the day, you've got an enormous opportunity here, but if you don't provide good care, you don't have the right providers, then it's a house of cards that'll come down.

With that, I think we'll wrap up this segment. Terry, thanks for joining. You had a lot of insights. It's obviously a big sector, and it's going to be an active one for a long time to come. Thanks again.

Thanks, Geoff. Appreciate being on.

Thank you for joining us on this installment of The Capitol Corner. To learn more about today's discussion, please email host Geoff Cockrell at GCockrell@mcguirewoods.com. We look forward to hearing from you.

This series was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this series, you acknowledge that McGuireWoods makes no warranty, guarantee or representation as to the accuracy or sufficiency of the information featured in this installment. The views, information, or opinions expressed are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This series should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.