As we sit in the midst of the greatest health pandemic in a generation, the return of a buoyant M&A market within the care sector may feel a long way off. Whilst a return to normality any time soon is unlikely, there is reason to be optimistic.
Any active M&A market requires alignment between the value aspirations of acquirers and vendors. In the majority of sectors, this is unlikely to be the case in the short-term as businesses take time to recover from the COVID-19 pandemic and investors look to take a more prudent approach. The care sector, however, has a different set of dynamics which should lead to an accelerated recovery.
Firstly, the investment rationale for acquirers in the care sector will have been strengthened during this difficult period. Whilst other sectors have sadly wilted as a result of lockdown, the care home market has shown its resilience to fluctuations in the economy. This resilience, combined with ever-growing demand drivers, will attract investors looking for a “safe home” for their funds.
Secondly, the short-term financial impact should be less severe within the care sector than in other areas of the economy. Most care homes will have seen some decline in occupancy over the course of the pandemic due to a lack of new placements, but hopefully this will only be material in the worst hit homes. Likewise, staff sickness and PPE issues will no-doubt have caused numerous challenges in recent weeks, but the ability to attract new talent from the fallout of sectors such as retail may help to reduce the reliance upon costly agency staff going forward. Therefore, although care home operators will see a temporary decline in financial performance, for most this should only be for a finite period before bouncing back.
This combination of increased investor appetite and limited profit decline will allow a return to M&A activity in a reasonable timeframe. Any temporary downturn in financial performance caused by COVID-19 is likely to be well understood by investors and valuation multiples will be applied to profit on a “normalised” basis after removing the impact of the pandemic. Earnout structures will be heavily utilised to bridge any value expectation gap, whereby an element of consideration is deferred until certain future financial metrics are met.
However, the focus of M&A activity is likely to change as the usual challenges faced by the care market are exacerbated by COVID-19. The government has had to borrow heavily to fund the significant package of support to businesses and employees. The pandemic has rightly shone a light on the importance of the social care sector, however this new debt burden means that a considerable increase to social care funding in the short-term is unlikely. Combined with this funding pressure, a material increase in the National Living Wage to £8.72 in April 2020 will continue to squeeze the margins of operators.
Therefore, whilst the broader care home market will remain attractive to investors, these dynamics are likely to further increase the appeal of operators with limited reliance upon local authority frameworks. In particular, private pay elderly care providers and higher acuity specialist care homes will attract premium valuations, leading to greater M&A activity in these areas in the coming months.