As we enter the second half of 2024, there’s growing optimism in the private equity (PE) community regarding the future of healthcare investments. While overall deal flow had been somewhat sluggish in recent months, industry insiders are now predicting an uptick in deal activity, particularly in the behavioral health sector. According to a new report from PitchBook, investors are increasingly eyeing the behavioral health space, with the market poised for a shift toward outpatient behavioral health investments and government-backed health plans. The renewed interest signals that now may be an ideal time for investors to focus on mental health, especially in light of favorable trends in reimbursement, patient demand, and overall market conditions.
Outpatient Care: The New Frontier for Behavioral Health Investment
Historically, private equity investments in the behavioral health sector have spanned a wide range of services, from inpatient and residential care to outpatient programs. However, the latest trends suggest a significant pivot toward outpatient behavioral health investments, which are becoming increasingly attractive for investors. This shift is largely driven by the challenges associated with inpatient and residential treatment, particularly related to reimbursement rates, geographic coverage, and the operational complexities of managing full-continuum care facilities.
Outpatient behavioral health investments have gained favor for several key reasons. First, the reimbursement rates for inpatient and residential services have been under pressure, making these settings less profitable compared to outpatient services. In contrast, outpatient care offers flexibility in delivery, lower costs, and the ability to serve a broader geographic area, particularly in urban and suburban settings where there is significant demand for mental health services. As healthcare payers push for shorter inpatient stays and greater reliance on home- and community-based care, outpatient behavioral health investments are becoming an increasingly vital part of the mental health ecosystem.
Private equity investors are recognizing that outpatient mental health services—ranging from therapy sessions to virtual mental health platforms—represent a significant opportunity. These services align with the broader trend of patients seeking care that is more accessible and less disruptive to their daily lives. With the rise of telehealth, online counseling, and mobile mental health apps, there are ample opportunities for growth, especially for those companies that can tap into the changing preferences of patients and healthcare providers.
Medicaid, Medicare, and the Rise of Government-Backed Plans
In addition to the shift toward outpatient behavioral health investments, there’s another development that could have a profound impact on private equity investments in behavioral health: the increasing role of government-backed health plans, particularly Medicare and Medicaid. The report from PitchBook suggests that the growing emphasis on mental health within government programs is likely to create new avenues for investors in the behavioral health space.
Over the past several years, Medicare has expanded its coverage for behavioral health services, and the trend shows no signs of slowing down. The launch of Medicare Advantage plans, which offer additional benefits beyond traditional Medicare, has been a key driver of this expansion. Investors are keenly aware of the potential of these programs to provide steady revenue streams for mental health providers, especially as more seniors seek mental health services.
Talkspace, the virtual mental health provider, provides a prime example of how companies are capitalizing on these opportunities. Earlier this year, Talkspace entered the Medicare market, offering its services to 13 million members across 11 states. The company plans to expand further in the coming months, a move that underscores the growing importance of Medicare in the mental health market.
Medicaid reimbursement rates, while varying from state to state, are increasingly competitive with commercial rates. As a result, Medicaid is becoming an attractive payer for many behavioral health providers, especially those that focus on outpatient behavioral health investments. The combination of improved Medicare coverage, expanding Medicaid reimbursement, and the increasing recognition of behavioral health’s importance is expected to open up new growth opportunities for private equity-backed behavioral health operators.
Labor Challenges and the Impact on High-Acuity Care
Despite these positive developments, challenges persist, particularly in higher-acuity segments such as inpatient and residential care. The labor market remains a critical concern for behavioral health providers. Inpatient and residential facilities, which treat individuals with more severe mental health issues, often face difficulties in recruiting and retaining skilled staff, a problem that has been exacerbated by the high stress and emotional demands of working with patients in these settings.
Although labor cost inflation decreased from around 8% in 2022 to below 5% in the final quarter of 2023, higher-acuity care businesses are still struggling with employee retention. In outpatient behavioral health investments, on the other hand, providers have had greater success in managing labor costs and retaining staff, making outpatient services a more stable investment opportunity.
This challenge is compounded by the fact that inpatient and residential facilities often draw their patient base from wide geographic areas, making it difficult to build an adequate network of providers and facilities that can effectively meet the needs of a large population. This geographic complexity, along with the need for more staff and specialized resources, makes high-acuity care a much more challenging—and expensive—business model compared to outpatient behavioral health investments.
Headline Risk and Regulatory Concerns
Another significant factor that could influence private equity activity in the behavioral health sector is “headline risk.” As the PitchBook report notes, there has been increasing scrutiny of residential treatment facilities, particularly those that treat adolescents. A paper published in June by the U.S. Senate Committee on Finance exposed instances of abuse and neglect at several residential treatment centers, which has raised concerns about oversight and patient safety.
While no private equity-backed companies were named in the report, the issue has led to increased regulatory scrutiny, with Senate Chair Ron Wyden signaling that legislation may be introduced to address these concerns. The fear of further negative media attention or legislative action has the potential to dampen investor enthusiasm for higher-acuity behavioral health businesses, particularly those focused on adolescent care.
This “headline risk” could become a more pressing concern as the 2024 U.S. presidential election approaches. Even if the political landscape shifts, the issue of regulatory oversight in behavioral health will likely remain a hot topic, further complicating investments in this space.
Platform Trades and Consolidations in Behavioral Health
Despite these challenges, the behavioral health market remains dynamic, and there are still ample opportunities for private equity investors to capitalize on platform trades and consolidations. According to the report, more than a dozen private equity-backed mental health companies in the U.S. or Canada have been held by their current sponsors for over five years. Companies like Odyssey Behavioral Healthcare (backed by The Carlyle Group) and Discovery Behavioral Health (backed by Webster Equity Partners) are among the names to watch for potential sales.
The trend toward consolidation is expected to continue as investors seek economies of scale, more efficient operations, and a broader geographic reach. As smaller mental health providers are acquired or merged, larger platforms will have greater bargaining power with payers, suppliers, and other stakeholders, increasing their overall market influence.
Additionally, the growing focus on mental health within the behavioral health sector is evident in the rising share of deal activity related to mental health services. Mental health made up just 29% of all behavioral health deal activity in 2017, but by 2023, it accounted for a whopping 71%. This shift reflects both the increased demand for mental health services and the growing recognition of the need for specialized treatment options in this area. Outpatient behavioral health investments are a key part of this trend.
Conclusion: A Promising Future for Private Equity in Behavioral Health
Looking ahead, private equity investments in behavioral health are likely to experience significant growth, particularly as the sector shifts toward outpatient behavioral health investments, government-backed health plans, and mental health-focused services. While challenges related to labor costs, geographic coverage, and regulatory scrutiny persist, the opportunities in the market are substantial.
For private equity investors, now is the time to re-evaluate the behavioral health space, with a particular focus on outpatient behavioral health investments, virtual mental health platforms, and government reimbursement plans like Medicare and Medicaid. As these trends continue to evolve, those who can navigate the complexities of the behavioral health market will be well-positioned to take advantage of the opportunities that lie ahead. With demand for mental health services at an all-time high, and with reimbursement structures becoming more favorable, the second half of 2024 could be the beginning of a new era for private equity in the behavioral health sector.
