A Methadone Cash Cow
CRC is Minting Money With Methadone, But Its Opiate Clincs May Not Play Well on Wall Street
by Ted Jackson
About four years ago, Phil Herschman approached Barry Karlin with a deal to buy a group of methadone clinics scattered throughout the country. Ultimately, Karlin teamed up with Herschman and bought the methadone clinics in a transaction that was to set CRC Health Group down a very profitable, yet potentially controversial, path of major expansion into the methadone maintenance business.
Methadone maintenance is disdained by many in the treatment industry as a therapy that simply replaces addiction to one drug for another. And while much of the medical community and government agencies like SAMHSA have been strong supporters of maintenance programs, saying they are highly successful, critics charge that methadone programs are mostly successful at controlling the social costs of opiate addiction, doing little to promote actual recovery from the disease.
Despite the potential for controversy, Barry Karlin, CRC’s CEO and founder who built the company into the nation’s largest addiction treatment enterprise, has plunged head first into the methadone business. In the process, CRC has become the country’s largest dispenser of the drug by far, with 61 clinics scattered across many states.
Controversial Foray
And yet, Karlin may be sensitive to the controversial nature of the methadone forays. In many interviews with Treatment Magazine over nearly two years, he has rarely mentioned his methadone investments, also preferring usually to refer to the business as “opiate” rather than methadone. And Karlin has also seemed to prefer to emphasize the importance of the equally fast growing residential side of CRC’s business. [Editor’s Note: Immediately following publication of this article CRC stopped breaking out its opiate business altogether in its financial statements and has undergone a number of confusing reporting segment changes that make understanding the company’s accounting, as well as making financial comparison’s, over time very difficult.]
But recent filings with the Securities and Exchange Commission reveal that methadone maintenance has for the last several years been a very central mainstay of CRC’s operations, although it will be less so in the wake of big treatment acquisitions like Sierra Tucson and Aspen Education. The filings also reveal that methadone is by far the most profitable segment of CRC’s now far flung addiction treatment business. From 2003 to 2005, CRC grew its methadone operation by about 130 percent, with annual opiate revenues reaching almost $84 million, which equaled 40 percent of CRC’s sales in 2005. However, during the same period, operating profits from the methadone segment soared by 240 percent, suggesting that CRC has been able to bring substantial economy of scale efficiencies to the business. Marketing prowess also comes into play, as 82 percent of clients are private pay, with clinics averaging 428 clients each, twice the industry norm. And the profitability of CRC’s methadone business far outstrips that of its residential segment, with operating margins from the opiate division reaching an eyepopping 37 percent in 2005, versus the 26 percent operating margins registered by residential treatment. Despite Karlin’s protestation that debt leverage at CRC has been “modest,” the company has in fact for years been a very leveraged enterprise, reflecting the desire of big institutional and private equity investors like Credit Suisse, the Ontario Municipal Employees Retirement System and, more recently, Bain Capital, to earn outsize returns.
No doubt the steady cash flows of CRC’s very predictable and profitable methadone clinics have been attractive to today’s high yield debt investors, who recently bought $200 million of CRC bonds.
Leveraging Methadone
Such high yield bonds are now a fixture of the country’s debt scene, but decades ago it was conservative companies like electric utilities that dominated the corporate bond markets. Being as they sold an every day human need like electricity, their steady cash flows were ideal backing for bonds. Also, utilities were monopolies whose sales were thus doubly immune from business cycle fluctuations.
Phil Herschman, who now oversees CRC’s methadone operations, says that in most of the markets in which CRC operates clinics there is competition, but other methadone clinic investors point out that, in many markets, clinics operate as monopolies. In this sense, but mostly because they sell an every day human need – which opiates are to an addict – methadone clinics are similar to utilities, and thus ideal for backing debt. In reality, though, methadone may in fact be an even better business for today’s highly leveraged finance players, mainly because methadone appears to be far more profitable than electricity. And opiate addicts have proven time and time again that they are willing to go without electricity, or even food, to get the opiates they need, another reason why Barry Karlin may have found the ultimate turbo-charged leveraged investment for his private equity backers.But what plays well in the debt markets, which are little understood and little followed by the general public, might not play so well in the high-profile market for stock IPOs, which Bain Capital is no doubt eyeing as a principal avenue of exit from its CRC investment.
“Ugly Business”
A former investment banker and very successful entrepreneur in the insurance arena – he founded Alexander Hamilton Life, which, when sold, had $50 billion of policies in force – Keith Owens has also emerged as among the nation’s leading players in efforts to build, with his Brookside Institute, a highly medical model of addiction treatment.
But during the late 1990s, Owens was principally occupied with an aggressive attempt to build a multistate methadone clinic operation through the purchase of 23 fraud ridden clinics he hoped to turn around. After five years and about $2 million, the effort ultimately got bogged down, but not before Owens learned just about everything there is to know about the methadone business.
One thing that gave him a lot of pause, and was a factor in the deals not panning out, was the fact that Owens ultimately became convinced that his plan to cash out by taking the clinics public might very well never come to fruition. That’s because he found significant resistance among potential investors to the idea of investing in a methadone clinic IPO, mainly because the methadone business was perceived as too controversial and unsavory. “Investors were leery. It was not going to be an easy sell,” Owens says, adding that, overall, methadone can be an “ugly business,” and often rife with fraud. Most of the owners of the clinics he was looking to acquire were facing big fines, largely from a common scam where Medicaid and Medicare were billed for counseling services never delivered, with the clinics acting simply as dispensing mills.
Higher Standards
With ownership of the nation’s 1,000 methadone clinics widely dispersed – Colonial Management, the next largest player, has just over 50 clinics – there is likely plenty of room for CRC to grow by acquisition without paying big premiums. There is also plenty of room for CRC to bring to the methadone business its quite high standards of conduct and clinical effort, which the company most definitely appears well on its way to doing. One area that CRC has so far had quite a small presence in is the outpatient arena, which won’t be for long. That’s because Herschman has been engaged in a grueling regulatory effort recently to license CRC’s methadone clinics so that they will be able to deliver a full range of outpatient care. “We are in the process of vastly expanding the range of services we offer at the clinics,” says Herschman, adding that the opiate division will henceforth be referred to as CRC’s outpatient division. The clinics from now on will be comprehensive treatment centers, offering outpatient detox, traditional IOP and a special IOP track to handle the fast growing demand for specialty methamphetamine care. In October, CRC admitted its first two patients into outpatient treatment at the methadone clinics.
And CRC also appears to be innovating clinically at the clinics, having instituted a novel Maintenance to Abstinence track, which is a two year program geared toward those who want to get off methadone. Clients are stablized for a year on an appropriate dose of methadone, then brought off the drug over 4 to 6 months, followed by a continuing care period. Overall, the strategy of broadening the scope of the methadone clinics is likely to prove brilliant on a number of levels. Not only does it allow CRC to leverage the facilities to enter a business it has less of a presence in, but it also allows for the leveraging of the company’s marketing competence and its enormous penetration into the commercial payor space. Going forward it will be less possible to determine methadone’s contribution as it becomes commingled with outpatient, but it seems likely methadone will continue to play a key role in backing CRC’s debt fueled growth.
