Current State of the UK Economy & the Early Years Sector
On 9 June 2021, OakNorth Bank hosted a webinar on the current state of the UK economy and the early years sector. The speakers were: Courteney Donaldson (Managing Director – Childcare & Education, Christie & Co), Lord Philip Hammond (former Chancellor of the Exchequer) and Ben Barbanel (Head of Debt Finance at OakNorth Bank).
Below are some of the key takeaways from the event, which we hope will be of interest.
The UK Government’s role in the pandemic
In the short-term, the Government’s strategy was to try to limit the number of businesses failing and jobs being lost because of temporary liquidity pressures caused by COVID. It therefore flooded the system with liquidity both through fiscal relaxation, but also through the Bank of England contributing an extremely loose monetary policy.
This has a number of consequences for the medium-term and has meant that in the short-term, very few businesses have gone bust compared with what the numbers could have been. This is because many businesses that needed emergency capital could get it via schemes such as the Bounce Back Loan Scheme and the Coronavirus Business Interruption Loan Scheme. Both schemes have since been superseded by the Recovery Loan Scheme.
However, this level of fiscal stimulus cannot go on forever, and it is clear we are not going back to life as it was before. There is going to be a different way of living our lives, running our businesses, and doing pretty much everything we do, and that will require structural changes in the economy. As in any period of structural change, there will be opportunities for those who are well-capitalised, who are bold and confident, and who have a thirst for expansion.
Over the next several months, we will see lots of government support and loose monetary policies - such as emergency funding, rent relief from landlords, VAT holidays or referrals - coming to an end. This will lead to a cliff edge, dividing businesses into two streams: those which are going to surge ahead and do well in the recovery, and those which unfortunately are not going to make it through.
I would expect this to lead to a bow-wave of M&A activity in the second half of the year, and we are starting to see this get underway as more potential purchasers begin to test the market.
The wider economic picture
The public feels very positive about the vaccine rollout, regarding it as a particularly British triumph. It looks like there is going to be strong growth for the rest of the year and early next year - perhaps as much as 6-7%. This is, of course, making up lost ground from a relatively low starting point but, nonetheless, it will feel like the economy is booming. New jobs are being created, many consumers have managed to save quite a lot of money during the lockdown and are keen to spend it, house prices are at a record high and, as yet, it appears there are going to be no immediate tax increases (unless you are a corporation paying off the huge cost of the crisis).
As we go into the latter half of next year, we are likely to return to our long-term trend rate of growth (around 1.25%) and we will once again need to focus on the long-term structural challenges that we face in the UK. The productivity challenge, for example, where British workers are working longer hours for lower wages than their competitors and British businesses do not have the benefit of a more productive workforce. The UK has fallen behind many of its European competitors and the USA when it comes to productivity.
What’s in store for government funding over the next few years?
In the short-term, we’re going to see several drivers of the feel-good factor, but in the medium-term, we will have to deal with several challenges. These include the productivity challenge mentioned previously, skill shortages, our cities and their relative under-performance compared to cities in most other modern economies, and the imbalance in regional distribution across the UK economy – plus the ageing society, technological change on an unprecedented scale and decarbonisation.
We have a government which was elected on the back of some extravagant promises, but this has come at a high cost - the UK has record-levels of public debt (over 100% of GDP or more than £2 trillion). Paying this off is a political impossibility; the realistic target is to slow its rate of growth by reducing the deficit, so public spending will likely be constrained in the medium-term.
Despite the somewhat gloomy analysis, there are still reasons to be cheerful. One of the important long-term trends in our economy is the rapid tech revolution that we are going through in virtually every area of activity. Almost every product we consume is undergoing digitisation and automation, and leveraging artificial intelligence and machine learning which is playing a big part in the operation of our economy. Through this, we can start to address Britain’s productivity challenge and perhaps provide an escape route from the trap of low productivity that the UK has endured for many years.
The entrepreneurship of the British people is another huge positive, too. We react to adversity by starting more businesses and exploring new routes to earn a living and generate wealth. Our time zone is also brilliantly positioned for international trade, and our educational institutions are world-leading, holding several of the top spots on international league tables. To exploit these benefits and get back to stable public finances, some difficult decisions need to be made and, unfortunately, populist governments do not tend to make difficult decisions.
Recruitment and staffing challenges
Businesses that are seeing demand for their services increasing are seeing bottlenecks in the supply chain and are struggling with staff supply and recruitment. Astonishingly, given that we have been under lockdown for most of the last year, there is a shortage of people in the hospitality sector - they are really struggling to recruit staff, to reopen hotels, restaurants, bars, and clubs that have been closed for a relatively long period of time. In the construction industry, a bad situation is becoming a disastrous situation in terms of availability of labour, skilled traders, and materials. Across other sectors as well, we are starting to see some real challenges as the economy reopens and gets going again.
It is interesting to think about what the tech revolution is going to do to the labour market. There are many professions which are currently high status and high pay, for example, insurance actuaries, which are going to be increasingly eroded by artificial intelligence and machine learning. However, some generally lower-paid roles, such as personal care and social care work, are not going to be so easily replaced by technology. So, we can expect those jobs to acquire a higher status and probably higher renumeration too over the coming decades as the “hierarchy of labour” gets turned on its head.
The pandemic’s impact on the childcare & education market
We’ve come an incredibly long way in the last 12 months, as it was about this time last year that schools and non-essential retail were starting to reopen following the first national lockdown. At which point, momentum gathered pace, and operators of childcare settings were battling with delivering care to frontline workers despite there being very little guidance around this.
Operators shone through and the profile of the UK early years sector has been raised as a result. By the end of 2020, Christie & Co had closed over 90 early years transactions. We saw a very high level of demand, appetite, buyer engagement and there was actually a lack of opportunities across the market as operators had been so busy trying to stabilise their ships.
So far in 2021, confidence and optimism have grown, and we have seen a raft of transactions already this year, with two recent very significant announcements in the sector: the sale of ICP nurseries, a portfolio which has been built and steadily grown over a small number of years and an acquisition by Partou which has invested in a majority shareholding in Just Childcare Nurseries.
There is a real feeling of business opportunity in the marketplace at the moment and buyer demand remains high. We are seeing no notable diminution in value at this stage, and pre-pandemic levels of pricing for nurseries is being achieved which is fantastic.
There are, however, still challenges that lie ahead. During Q1 2021, corporate insolvency across England and Wales was at its lowest level since 1989 - that’s a phenomenal 32-year low which is no doubt thanks to the government stimulus over the last 15 months. This means we’re in an artificial environment, so it will be interesting to see what happens as the stimulus comes to an end.
The early years sector will have huge opportunity for consolidation over the coming months and those who successfully consolidate, build a broader base, and a wider geographical spread, will be that much stronger and well-positioned for the longer-term structural changes throughout the economy.
The disruption to working patterns resulting from the pandemic will have a huge impact on many businesses across the economy, including in the childcare and early years sectors. How, and where, we live and how often we commute to work will impact how much childcare we need for example. People will either want childcare close to their place of work or close to where they live – and both of those may change as a result of the pandemic, so early years providers and operators need to be thinking about this when it comes to deciding on new locations to develop or sites to purchase.
Is ringfencing of early years funding something Rishi Sunak should be looking at going forward for the early years services?
Not likely. Local government has taken quite a beating from central government over the last decade or so and borne a huge brunt of the adjustment in managing public finances. It also has some very strong views about ringfencing and being treated as an equal partner. Fortunately, local government is very resourceful, and local government leaders are thinking about how to support themselves and not rely on central government.
How do we get government funders to value the charity sector when competing with private equity firms?
This is not a new question; we have been looking at this for nearly 20 years. The challenge, however, is that everyone’s budgets are under pressure and if you’re the early years commissioner for an authority, you may be aware of the wider benefits that come from one provider rather than another, but you may not necessarily have the budget capacity to pay extra for that. It is very difficult to persuade any bureaucratic organisation to put a value and price on something that can’t be measured.
If you believe that you add value beyond the core proposition that you are offering - e.g. “I will deliver early years education, but I will also deliver additional value in the form of X, Y, Z.”, then you need to be able to quantify that and set up metrics to enable the commissioning authority to measure it.
There is a boring point that must be made, too, around the procurement process and procurement law. Of course, there has to be a level playing field, and it’s not easy for an authority to give extra points post the event for some additional value that some providers might offer. This must be built into the original structure of the tender in order to ensure the validity of the tender itself doesn’t get challenged.
It is important for private equity firms that are considering purchasing a nursery portfolio not to underestimate the personal side of buying a business. Many business vendors want reassurance that their legacy will be taken off by the buyer, so knowing that you will be carrying on their ethos will be very valuable to them.
Boris Johnson has a commitment to invest in infrastructure and, increasingly across the world, we are seeing early years being seen by governments as essential infrastructure through commitments from President Biden in the USA and Scott Morrison in Australia. The early years workforce has been integral to those countries during the pandemic and will play a vital role in helping get them back on track.