Consolidation resumes in the UK’s childcare sector

For several years, childcare was among the UK’s most active dealmaking sectors. Like the veterinary sector, childcare offered consolidators and acquirers the perfect mix of reliable revenues and a highly fragmented market.

However, unlike the veterinary industry, which proved largely immune to the worst effects of COVID-19, the pandemic immediately forced the childcare sector into shutdown and dealmaking suffered accordingly.

Despite this stop-start 18 months and continuing uncertainty surrounding COVID-19, M&A in the childcare sector is showing clear signs of recovering, with a number of major acquisitions in 2021.

As the impact of COVID-19 continues to be felt and the UK begins learning to live with the disease, what are the factors and challenges that are currently shaping the childcare sector and, most pressingly, what is the M&A outlook for this busy sector?

As things stand

Prior to COVID-19, deal volumes in the childcare sector were increasing rapidly year on year but suffered a 22 per cent drop in 2020 compared to 2019. However, in spite of this decline, deal volumes for 2020 were still 12 per cent higher than for 2018, highlighting the sector’s rapid growth.

Indeed, while deal volumes were down overall, childcare represented something of a safe haven for those looking to deploy capital during the pandemic, due to factors including government funding and the market’s continuing fragmentary nature.

Fragmentation
Childcare is a highly fragmented sector with ripe opportunities for large-scale consolidation, as well as growing demand. Figures from 2018 showed that, at the time, the UK’s nurseries market had in excess of 20,000 operators, with no individual group at the time having more than a 5 per cent market share. This means a lot of operators were running either a single site or a small number of sites. Again, as shown by the veterinary industry, such operators make prime acquisition targets, particularly in the wake of economic shocks.

Even though M&A has continued apace since then, the scale of the fragmentation depicted by those numbers, as well as the downturn in dealmaking occasioned by COVID-19 means that opportunities to consolidate on a wide scale will still be numerous. In the wake of the pandemic, many single-site operators and operators with small portfolios have taken an economic hit during a year of disruption.

With the nursery sector so ripe for consolidation, the ability to acquire a number of single sites or smaller portfolios could represent the perfect opportunity to begin acquiring at scale for operators that are looking to rapidly build a strong estate of childcare facilities.


In August, nurseries group Kindred Education acquired the three Cambridgeshire sites that had previously comprised the HRH Nurseries group. The trio of acquisitions, supported by a funding package of £7.5 million from Santander UK, took Kindred Education’s portfolio to 21.


Kindred Education, which was founded in 2015, has grown to encompass around 450 staff in its 21-strong portfolio. Over the next five years, the company aims to acquire 30 new childcare sites and grow its workforce to approximately 750.

Strong demand
Despite birth rates and overall birth numbers falling in the UK for the best part of the last decade, demand for early years childcare services has continued to record strong growth over recent years, up until the onset of the COVID-19 pandemic.

This has been driven by the preferences of parents and shifting trends in the employment market, with fewer parents than ever choosing to be stay-at-home dads or mums. Naturally, this growth creates increasing revenues and potentially creates challenges for smaller operators to meet new demand, feeding into consolidation.


One of the most acquisitive companies in the childcare sector is Welcome Nurseries. Established in 2019, the firm has since grown entirely through acquisitions to become a top five group in the sector, with over 50 settings and more than 5,000 childcare places. Welcome Nurseries principal Jonathan Jay has worked closely with Business Sale Report for years and recently discussed the firm’s operations and plans for the future with us.


Regarding the company’s recent activity, Jay said that, while many competitors had paused their acquisitive activities amid the uncertainty of the COVID-19 pandemic, Welcome Nurseries had carried on, completing 47 acquisitions since the start of the pandemic.


While this has mainly been focused on smaller deals in the North of England and Midlands, the company is beginning to speed up its activity and target larger deals. The company’s aim is to create a fully-utilised network of nurseries in which resources and staff can be shared.


The company is currently targeting £20 million in EBITDA and, over the next 36 months, aims to reach 150 locations in the UK. Internationally, Welcome Nurseries is currently setting up a company in Dubai and will soon begin targeting acquisitions in the United Arab Emirates.


Looking at the wider M&A picture in the UK’s childcare sector, Jay drew attention to the wide range of dealmaking in the market, from smaller deals to far larger ones, such as Oakley Capital’s recent £180 million takeover of ICP Education.


Despite this activity, Jay pointed out that new players face numerous barriers to entering the market, with regulation the key obstacle. Any new market entrant requires OFSTED approval, which, Jay says, might be difficult to attain for buyers with no previous experience in the sector.


But, as Welcome Nurseries show, the UK’s childcare sector offers incredible scope for new entrants to grow through acquisitions. Sharing an insight into the company’s success, Jay revealed that the firm’s acquisition process had been improved by bringing a highly qualified partner on board from the start.

Private equity
If there’s one thing that a fragmented market offering high growth, government support and a safe investment will attract, it’s private equity interest. For private equity investors, the childcare sector offers the perfect opportunity to acquire companies and launch buy-and-build acquisition strategies that aggressively consolidate large numbers of locations.

Furthermore, with private equity activity in the sector having been strong for several years now, this will also continue to generate deal activity through divestments, as private buyers cash in on investments made years ago.


This interplay between private equity firms either investing in the sector or cashing in on previous investments was perfectly illustrated recently in the acquisition of Poppy & Jacks by fellow nursery provider Kids Planet in July 2021.


North West-based Poppy & Jacks had been backed by regional private equity firm Foresight Group, which exited the deal as part of the acquisition by Kids Planet, which is backed by private equity growth fund BGF.


The acquisition saw Kids Planet grow its footprint in the North West and Midlands to 75 nurseries, caring for over 10,000 children. Kids Planet was initially backed by BGF in 2016, when the fund put £10 million into the business which, at the time, operated 17 nurseries.


Since then, BGF has made five follow-on investments, investing £41 million in total to support Kids Planet’s growth and enabling the business to more than quadruple its portfolio in just five years.


Commenting on the deal, Pinesh Mehta of BGF said: “This is a fantastic deal for all involved as Kids Planet continues with its successful expansion and proven acquisition strategy. There’s still significant potential across the UK as the business continues to expand in the North West and beyond.”

Childcare as a property-based market
Aside from private equity firms, parties taking a strong interest in acquiring portfolios of nurseries include property investors. For such investors, private equity divestments of large portfolios and, in the wake of COVID-19, struggling multi-site operators, will represent ideal opportunities to acquire commercial property at scale, with the knowledge that they are tapping into a safe sector benefiting from virtually guaranteed government subsidy.

As such firms will typically have little interest in operating the sites themselves, buy-and-leaseback sales to property investors could offer the perfect opportunity for owners to generate capital through a sale, while enabling the buying firm to acquire a valuable portfolio with strong resale value and recurring income through rent.


In the late summer of 2021, property investment firm LXi REIT acquired a portfolio of 23 nurseries in the UK from KidsFoundation for £34 million, before immediately leasing the sites back to the company.


The deal followed LXi REIT’s £100 million share placing in July and was its first sale-and-leaseback deal in the UK’s childcare sector. The £34m price tag represented an accretive net yield of 5.5 per cent.


Commenting on the deal, LXi REIT said: “The Nurseries are well located across England, with strong and affluent catchment populations and the rent has been set at a sustainable level to produce a high rent cover of 2.75X on an individual asset basis. This ensures the rent remains affordable for the tenant whilst the investment is also underpinned by vacant possession value.”


"Each property benefits from a new, unbroken 30-year lease to the top entity within the KidsFoundation group. The rent increases on an annual basis in line with RPI inflation until 2030, from which date the reviews convert to CPIH inflation plus 0.83 per cent per annum. The reviews contain a collar of 1 per cent per annum and a cap of 4 per cent per annum.”


John White, a partner at the property investor, added: "We are delighted to have made this first, substantial sale and leaseback acquisition for the company in the robust nursery school sector. The portfolio provides LXI with highly secure, inflation-linked and diversified 30-year cashflows, supported by sustainable rents and strong residual values."

Challenges facing the childcare market

COVID-19
The COVID-19 pandemic forced many schools and nurseries to close for months on end during 2020 and, as well as majorly impacting M&A activity in the childcare sector, is bound to affect both revenues and consumer behavior for at least the short to medium term.

With the government hesitant to impose renewed lockdown restrictions, COVID-19 is on the rise again across the UK. Childcare settings, in particular, which involve close mixing of many people in a confined space for hours on end throughout the week, are seen as major vectors of infection. They are susceptible to outbreaks of infection among both children and staff. With major outbreaks potentially coming with the threat of prolonged closure.

A longer-term risk for early years childcare facilities is that this vulnerability to outbreaks will make parents less willing to put their young children into nurseries or other childcare, due to the risk posed to the child and their wider family. Tangentially, the economic fallout of the pandemic could also impact the disposable income of younger parents, potentially making them less likely to invest in private early years care before their children go to school.

Finally, it remains to be seen what the impact of the change in working habits during the pandemic will be. It may be the case that the increased flexibility that many workers now have will mean fewer opt to use childcare. Conversely, the growing reliance on the family home as a place of work may mean that some are more inclined to invest in childcare for their young children.

Ultimately, the impact of the pandemic remains largely to be seen, which could contribute to a continuing sense of uncertainty in the childcare market over the short- to medium-term.

Baby boom or bust?
Traditionally, tragic events (of which the COVID-19 pandemic has certainly been one) typically result in a baby boom a few months or years down the line, with the “boomer” generation born in the years following the second world war being the classic example.

The pandemic has similarly brought with it predictions of a sizeable baby boom, one which could fuel growing demand for early years childcare for years to come. The logic being that, with couples spending more time at home during the pandemic and having more time and flexibility to consider their futures, birth rates will rise.

Indeed, following an initial dip during the spring and summer of 2020, NHS antenatal booking appointments in Q4 2020 reached a five year high, with virtually all of those making appointments likely to have conceived during lockdown.

Further bolstering the baby boom view, a recent Opinium study found that close to 2 million babies could be born in the two years following lockdown, if 25-40-year-olds proceed with plans to have children. The survey found that millennials feel the pandemic had increased the value they placed on family life and led to many considering fast-tracking life goals.

Conversely, some have argued that the COVID-19 pandemic could ultimately lead to a sustained drop in birth rates, something that could damage growth in the childcare sector over the coming years. The view that COVID-19 will lead to a “baby bust”, rather than boom, is based upon the common wisdom that states that economic recessions will usually lead to birth rates dropping.

According to a forecast from PwC earlier in the year, birth rates in the UK are expected to drop to their lowest levels on record this year, driven largely by the impact of COVID-19. In addition to the economic impact of the pandemic, it has also been suggested that the social and cultural impact of COVID-19 could exacerbate existing concerns such as climate change and contribute to young people feeling less inclined to have children.

Despite such concerns, the UK’s current childcare market looks strong, particularly from an M&A point of view. As illustrated by the range of case studies above, dealmaking has rebounded strongly this year after a difficult 2020.

With the fragmented market home to a number of large and medium-sized consolidators, property firms taking an increasing interest in portfolios of nurseries and private equity firms who bought into the sector over the past decade looking to cash in on their investments, M&A in the sector looks well placed to weather the continuing uncertainty caused by COVID-19.

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