Why Diligence Matters: Don’t Buy Acadia Healthcare’s Roll-Up

We put behavioral healthcare provider Acadia Healthcare (ACHC: $51/share) in the Danger Zone just over a year ago, and the stock has been on a wild ride since. The stock plummeted nearly 40% in the second half of 2016 on the back of disappointing earnings and regulatory concerns over its acquisition of Priory Group. Most of that decline has been reversed in 2017 due, in large part, to political developments.

Overall, the stock is down roughly 4% since our original report against a 14% gain for the S&P 500. Despite the company touting its impressive non-GAAP numbers, the stock is just as dangerous as ever.

Non-GAAP Numbers Mislead Investors

Acadia and other companies that pursue a roll-up strategy often benefit from the confusion and opacity surrounding their financial statements. Acquisitions create unusual, non-recurring expenses that distort GAAP net income, which companies like to use as justification for touting their own non-GAAP metrics instead.

For Acadia, “Adjusted EBITDA” is the non-GAAP number to which they point investors. Here’s a helpful hint: if a company talks about Adjusted EBITDA, run. The metric is a favorite of roll-up schemes such as Verint Systems (VRNT) and Valeant Pharmaceuticals (VRX) as well as highly unprofitable companies like Snapchat (SNAP) and Pandora (P).

Adjusted EBITDA lets companies ignore all the capital costs involved in acquisitions (for which they often over pay) and throw out real operating costs such as stock compensation while they’re at it. Figure 1 shows just how much Acadia’s Adjusted EBITDA diverges from GAAP earnings and economic earnings over the past few years.

Figure 1: Acadia’s Adjusted EBITDA Dramatically Overstates Profits

(Click on image to enlarge)

Source: New Constructs, LLC, and company filings

Exec Comp Plan Rewards Value Destruction

2016 saw Acadia report record profits on a non-GAAP basis even as the company destroyed record amounts of shareholder value with the $2.2 billion Priory Group acquisition.

As a result, executive compensation soared to new heights even as cash flows plummeted. CEO Joey Jacobs earned $9.4 million in 2016, his highest annual compensation on record, despite Acadia posting its worst ever economic earnings and the stock falling by 47%. As long as Acadia ties executive compensation to Adjusted EBITDA, its executives are incentivized to carry out expensive acquisitions that destroy shareholder value.

Roll-Up Strategy Still Isn’t Working

Acadia operates in the Behavioral Healthcare field, which focuses on treating people with mental illness and addiction. The industry is fairly fragmented, and the bull case for Acadia has rested on the idea that it can reap efficiency gains through consolidation.

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Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, style, or theme.

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