Wednesday, December 30, 2015

15th AIM student equity update by Dan Kralovec: Acadia Healthcare (ticker: ACHA): Is the Diagnosis and Prescription for More Acquisitions?



ACHC (Acadia Healthcare Company, Inc.): Can Acquisitions Heal This Healthcare Stock?
By: Dan Kralovec, student at Marquette University

Image result for acadia health logo
Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

 Summary

• Acadia Healthcare operates inpatient psychiatric facilities, residential treatment centers, group homes, and substance abuse facilities in the  United States and Great Britian. It competes in a highly specialized environment - and successful acquisitions have been (and are likely to remain) the main driver of growth.

• The industry is consolidating and success is driven by bed psychiatric bed count – and ACHC has added over 500 beds to their facilities in 2015. 

• Given the recent increase in mental health awareness, we should see a decision in FY 2016 with regard to US Medicaid laws that restrict thousands from seeking mental health services.  

Acadia Healthcare Company, Inc. (NASDAQ: ACHC) continues to show great growth potential despite the overall poor performance in the healthcare sector over the past few months. Acadia is an industry-leading provider of specialized behavioral health services to individuals suffering from mental health disorders and/or alcohol and drug addiction. ACHC operates 232 facilities between the U.S. and the U.K with a combined total of 9,200 psychiatric beds.

It’s difficult to establish a foothold in the behavioral health services industry due to a high degree of specialization. Likewise, this space has been subject to much consolidation as of late. Being a pure play healthcare company, ACHC has grown primarily through strategic acquisitions. This past year, they’ve acquired eight companies, which have added significantly to their facility portfolio and total bed count. Management recently affirmed that FY2016 should reflect this past year’s acquisition strategy. Last month, Acadia acquired MMO Behavioral Health system, its two locations with a combined 80 beds. The annual $16 million in revenue is expected to be immediately accretive to Q4 financial results.  To remain competitive, ACHC not only continues to acquire value added companies, but also allocates an enormous amount of time and capital towards the improvement of existing facilities to meet any increasing demand for a specific service. They’re constantly upgrading systems, security, and adding beds to already established locations.

The firm also drives growth through joint ventures with larger health systems and non-for-profits. Depending on the needs of the other party, Acadia utilizes their expertise to retrofit or develop entirely new psychiatric facilities. Much like the increased bed count, these relationships give the firm instant access to a much larger customer and referral base. ACHC currently has 10 projects like this in the works. Joint Ventures and acquisitions have been accretive in other ways besides increasing the customer base. For instance, ACHC just acquired the behavioral health segment and psychiatrist development program from the Einstein Medical Network last spring. With a market wide shortage of available psychiatrists, ACHC will have the option place graduates into their facilities as they see fit.

Looking forward, management believes the firm will generate $8 billion in annual revenue by FY2018, almost twice the estimate for FY16. Success will be directly proportional to the amount of beds the firm can successfully add to their existing and “newly acquired” facilities. Each facility has a development team tasked with handling the operations, requesting new beds if needed, and forecasting any potential change service demand. With management spending more time on acquisition targets, this group is absolutely vital to the success of the firm’s underlying operations going forward.

In light of the recent Planned Parenthood shooting in Colorado Springs, much attention has been directed towards our Nation’s insufficient mental health system. In recent years, there has been an increase in both mental health awareness and availability of treatments, hence ACHC’s aggressive acquisition strategy. Reimbursement rates have been strong amidst an otherwise uncertain regulatory environment. Medicaid laws prohibit the use of funds to finance payments to metal health and substance abuse facilities. Currently, legislation is in place to provide mental health coverage to adult Medicaid beneficiaries. Although the bill’s status is unknown at the moment, successful passage could increase their addressable market. It will be interesting to see how the affects, if any, on the companies bottom life in the months to come.

There has been much speculation in the market as to whether or not Acadia is attempting to buy the Priory Group, Britain’s largest rehab clinic with a bed count of over 7,000. To put things into perspective, each bed costs ACHC about $125,000. At the current rate of 500 beds/year, it would take ACHC about fourteen years and $875MM to grow organically to this magnitude. An acquisition of this magnitude would materially affect EPS and shareholder value. Although this transaction is currently speculation, the information may be “relevant” enough to the point that it could be priced into ACHC stock.

What has the stock done lately?

The stock is currently trading for around $61, down 12% from a month ago - and near its 9 month low. Trading volume remains steady despite the stock’s overall negative returns. Short interest has increased a bit (6.4% of float) compared to previous months. The company has beaten earnings estimates for the past three quarters. The most recent consensus target price on this stock is about $89.13, representing a 48% upside when compared to the current price. Considering the current stock price and the increase in short interest, a positive catalyst is defintley needed to spark an increase in ACHC’s share price.

Past Year Performance: Earlier this year, two venture capital firm sold about 4.8MM shares at an average price of $80. The stock price has since dropped by about 33%. Despite the recent poor returns, ACHC has increased 3% in value over the past year. The company is on track to meet Q4 earnings and sales estimates and there has been no major news to suggest any fundamental issues with the firm.


Source: FactSet

 My Takeaway
More mergers, joint ventures, and acquisitions are definitely a huge positive for a shareholder that may be concerned with the sustainability of ACHC’s business model. With that being said, bed expansion is one of the most important drivers of growth. Based on past results, it’s unlikely that we will see management cease their expansion strategy in the near future. The firm is defintley broadening their reach and expanding their service portfolio. In FY 2016 we should hear something with regards to the Medicaid mental health exclusion. However, there seems to be a bit of suspicion with regards to the outlook for the industry in an election year. A short interest of 6% isn’t all that worrying, but the increase from previous months should be noted. Lastly, it’s worries me that the reasoning behind the major recent selloff remains unknown. For these reasons, despite the attractive price, I would approach this stock with caution unless you believe that the consensus estimates are accurate and have a strong opinion that there will be a supporter of behavioral health care expansion in the White House in 2016!



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