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A Methadone Cash Cow
CRC is Minting Money With Methadone, But Its Opiate Clincs May Not Play Well on Wall Street
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.
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 quite a 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.
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