In May, the UK Consumer Price Index (CPI) for the month of April which is the recognised measure of inflation rose to 9% as reported by the Office of National Statistics (ONS). This is 7% higher than in the month of March marking its fastest surge in 40 years. The ONS reports the surge as higher fuel costs, increased food costs and the impact of Russia’s war in Ukraine as the reasons for the increase.
The governor of the Bank of England (BoE), Andrew Bailey has admitted he and his fellow BoE team felt “helpless” as their tools to reduce inflationary pressures are limited due to the extraordinary nature of the inflationary drivers. Traditionally, interest rates are used to deliver inflationary targets with the BoE working to a target inflation range of 2-3%. The challenge facing the BoE today is that every increase in interest rates will add cost of living challenges to variable rate mortgage holders and increase the cliff edge cost increases to fixed rate mortgage holders when their current fixed rate deals end. With the blame game in full swing, the Governor of the BoE informed the Treasury select committee that 80% of the inflation target overshoot was due to external pressures beyond the control of the BoE.
As we look ahead to the second half of 2022 many economic experts are forecasting a “twin peak” inflation event with a further inflationary surge expected to take place during Q4 2022 with inflation potentially hitting 10-15% as further energy, fuel and food price increases take effect. Recent statistics show the current food price inflation is currently being suppressed as food producers accept lower margins to try and reduce the consumer impact. Published food inflation data reports growth of 5.9% but analyst, Clive Black of Shore Capital, said food price inflation could leap as high as 12% over the summer, with milk alone up 30%.
Historically such economic data is usually a prelude to a deep economic recession which in turn leads to high levels of unemployment and business insolvency. It is widely anticipated the UK will enter a technical recession during 2022 as post-pandemic growth levels start to recede and the cost-of-living crisis takes effect on consumer demand. The Office for National Statistics has published data which shows the UK economy is slowing faster than expected with 0.7% GDP in January, no growth in February and a fall of 0.1% in March. It is important to note these growth figures have been supported by the considerable Government spending on Track and Trace, Covid testing, and the UK’s vaccine rollout program. The Quarter 1 slowdown is concerning given it precedes most of the inflation rise and the cost-of-living increase.
All in all, this presents significant challenges to the Childcare sector and obstacles which need to be overcome every day.
Nursery Sector – Defying Logic?
Why have we started this article on the challenges facing the sector? We have done this to highlight the resilience and buoyancy of the sector even during adverse economic and macro conditions.
In contrast to the weak economic data, mergers and acquisitions in the nursery sector is flourishing with significant levels of deal activity being announced across the UK, from Wee Ones Nursery based in London, Little Sea Horses in St Ives, Emmy Jaynes in North Yorkshire, Future Champions in the North-West and Wee Gems Nursery Group located in Edinburgh & West Lothian the wave of transaction volumes shows no signs of slowing down.
In January 2022 we published our market report which forecast “accelerated level of consolidation within the early year’s sector” and “increased activity in the regions”. As we approach the mid-way point of 2022 our opinions haven’t changed as the transaction data highlights strong consolidation across all parts of the UK with significant volumes and values of new deals agreed in the first five months of the year.
Childcare M&A Drivers
Change Drives Deals and M&A Activity
The number one driver behind the M&A activity in the childcare sector is the strategic expansion from the national operators who have high levels of liquidity, strong management teams and highly ambitious boards who are seeking to create a national footprint offering high-quality childcare. The market remains fragmented with the share of the market attributed to corporate operators remaining below 50%. The sector is changing and evolving, the drive from national and regional operators is reducing the traditional “Mom and Pop” operator levels and increasing the market share % of regional, national and corporate operators.
Wall of Cash
During the last few years, a “wall of cash” has built up amongst the investment community with the early year’s sector viewed in a positive light. This liquidity has filtered down into medium-term investments in strong groups with professional growth plans. The attraction of the childcare sector is the resilience and sustainability which has been demonstrated during the pandemic and how quickly many operators bounced back to profitability when the restrictions started to ease. Liquid and well-funded acquirers are in a strong position to move quicker than traditional bank-funded purchasers which have driven a significant reduction in deal completion times.
Value Acquisitions in the Regions
Pre-Pandemic the focus among many buyers was the desire to acquire strategic early years businesses predominantly in the South-East and key City conurbations. Intense demand led to deal multiple increases which in turn priced many buyers out of the market. Fast Forward to the present day and the deal activity is now Nationwide as many buyers acknowledge the benefits of acquisitions in regions which offer value when compared to purchase prices in the South-East and City conurbations.
Supply Driven by CGT Fears
Fears exist that Capital Gains Tax allowances will be removed entirely and without notice by the Treasury during the next budget statement. This has caused some childcare business owners to take the decision to sell in advance of any negative taxation allowance policies. In turn, this has created additional supply to the M&A market which has helped to fuel transaction volumes.
Headwinds
While we see M&A activity continuing at the current pace, we do acknowledge there are some headwinds in the market which have the potential to affect deal activity during the second half of 2022.
Recruitment
Earlier in the article, I referenced the economic data signalling a prelude to a recession. Whilst I believe this to be correct it is important to highlight the logic-defying situation that the UK labour market is in. In May, the Office for National Statistics announced, “for the first time since records began, there are fewer unemployed people than job vacancies”. During Q1 2022, 1,256,846 people were unemployed whilst during the same period, 1,295,000 job vacancies were being advertised by employers. During my conversations with childcare business owners’ recruitment is their number one concern with some owners having to reduce their growth aspirations until they can fill existing job vacancies.
Employee Costs
The UK Government has further increased the national living wage, employers NI and pension contributions which will add further inflationary pressure to the economy. This is compounded by the fact that our employees all face cost-of-living increases which are driving demand for significant wage increases.
Deal Scrutiny
We anticipate higher levels of scrutiny during the due diligence process as buyers seek to justify their acquisition target to their board/funders with the focus being on sustainability. During this period, it is imperative you have a proven broker working on your behalf who can keep the momentum in the deal. At RDK we recognise that “Time Kills Deals” which is why we always work with our clients to effect as tight a due diligence process as possible and advise our clients to provide the required information at the earliest opportunity.
Summary
In summary we are expecting a strong summer of M&A for the childcare sector with 2022 delivering a record year for transactions. We acknowledge the headwinds present and the macroeconomic factors, but our view is a positive one for providers who are looking to acquire and those who are looking to exit. Redwoods Dowling Kerr is owned and operated by directors who have run a variety of businesses throughout their careers, and we know the multitude of challenges in running a business. This is why we are well placed to advise childcare business owners on how to deliver their strategic goals and aspirations.
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