A rollup in rehab. Who's to blame for Therapy Brands’ descent from unicorn to sub investment grade?

Disclaimer: Views expressed here are the author's own and based on public sources. The article is intended for informational purposes only. This is not financial advice. Please consult a professional for investment decisions.

*********************

Enterprise software is meant to be highly profitable and resilient to churn. 

Tier 1 Private Equity is meant to be razor-sharp. 

So how come Therapy Brands, an American rollup of software providers to mental health and rehabilitation practices, acquired by KKR for $1.25B in 2021, recently had its debt downgraded to junk by Standard & Poor’s and Moody’s?

Welcome to the cautionary tale of a “rollup in rehab”. What happens when a federation of SaaS businesses is hit by a perfect storm of high leverage, competitive pressure leading to client defections, AND a cyber attack on a key supplier. 

In this article, we discuss:

• The Therapy Brands’ investment case

• What went wrong after the KKR takeover

• Lessons for buy & build aggregators - in software and elsewhere

Feels like deja vu, doesn’t it? In late 2023, we ran an article on Upland Software, the NASDAQ listed rollup of enterprise work management software tools that found itself in a similar predicament (high competition, high customer churn, high leverage).

Previously on RollUpEurope  

In September 2023, we covered the Therapy Brands story in detail. We strongly recommend you start with that article if you are unfamiliar with the business. However, if you are pressed for time, here are the highlights:

• Therapy Brands was founded in 2013 by Shegun Otulana, an immigrant from Nigeria, to consolidate the $140 billion US behavioural health market

• Providing financial and intellectual firepower to Shegun’s idea was a sequence of PE firms, including GSV, PSG, Lightyear Capital, Oak HC/FT, and finally KKR

• The happy finale - at the time of writing - was the 2021 acquisition by KKR for $1.25B (25x EBITDA / 10x revenue, both on a TTM basis)

During Lightyear’s ownership (2018-21), Therapy Brands’ revenues and EBITDA grew almost threefold:

KKR financed the acquisition with $970M in equity and $320M in debt. While debt represented only a quarter of the total funding, the eye-watering multiple paid by KKR translated into elevated leverage metrics: 9x EBITDA on a trailing basis, and c.6x pro forma recent acquisitions. 

In hindsight, the pro formas were WAY too optimistic. 

Still, ratings agencies like Moody’s and S&P happily rated the debt Investment Grade off the back of a compelling equity story characterised by:

• Recurring SaaS revenue streams

• High client retention rates (around 95%)

• Projected double-digit revenue growth

• Strong EBITDA margins (around 40%)

• Low capital expenditure requirements

All of these sound a lot like Constellation Software VMS attributes.

Or perhaps not?

In the same breath, the ratings agencies dutifully pointed out Therapy Brands’ weaknesses, including operating in a crowded market with (a) low barriers to entry and (b) larger, more established competitors. Therapy Brands was considered to be vulnerable due to its small size and narrow focus. 

These concerns proved prescient. 

Therapy Brands’ business model had two major vulnerabilities

Vulnerability #1 was being exposed to a heavily SMB customer base prone to churning. The US mental/behavioral health market is dominated by very small practices consisting of 1-2 clinicians. Moreover, it is a market with low barriers to entry, as shown by the large number of competing vendors such as SimplePractice and CentralReach. 

And not just any competitors. 

SimplePractice is a division of EngageSmart: a formerly public company that was taken private by Vista Equity Partners in 2023 in a $4B transaction. CentralReach has been owned by Insight Partners since 2018. 

As S&P wryly commented in May 2024: 

SimplePractice [...] spends significantly more on marketing, including Google search engine, and has a much larger customer base. As such [...] for Therapy Brands to remain competitive, it will likely need to continue investing in its products and marketing, which could limit its ability to grow margins as revenue increases. 

Let’s double click here. Again according to S&P, Therapy Brands concluded 2022 with c.$130M in revenue, c.$30M in EBITDA - and a free cash flow deficit -$9M. The following year, revenue grew (by 7%). So did EBITDA. Alas, so did the FCF deficit (to -$12M). 

In a relatively short period of time, Therapy Brands’ EBITDA margins slid from 40%+ to 25%, and cash generation collapsed.  

What happened? 

Subscribe to Premium to read the rest.