We shut down our SPAC — here’s why
By Tess Cameron and Matthew Hammond
Tess Cameron is a Principal in Strategic Finance and Matthew Hammond is a Principal on the Investment Team at RA Capital.
Image courtesy wikimedia commons @ customneonDecember 20, 2022
2020 and 2021 were the heyday for special purpose acquisition companies, or SPACs. We got in on the act ourselves – twice! – and we’ve learned a lot about why SPACs can sometimes work for a biotech in very particular circumstances, but also why mostly they don’t. We would also note that in certain market conditions, chasing merger targets with a SPAC can be extremely challenging. So after over a year and a half of valiant efforts to find a suitable target, we pulled the plug on our second SPAC. Here’s the story.
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Why a SPAC?
First we should talk about how SPACs work. These “blank check” shell companies raise capital via IPO, at $10/share, with the intention to seek out a merger partner. Once a deal is announced, the SPAC’s investors can choose to invest in the merged company. Importantly, they don’t have to – they can cash out their shares instead if they’re not psyched about the deal. The SPAC’s sponsor typically offers up additional capital via a PIPE which can include the SPAC’s investors as well as investors who didn’t invest in the SPAC. For a company that merges with a SPAC, it’s like combining two arduous processes (a crossover round and an IPO) into one arduous transaction.
Since the start of 2020, dozens of SPACs with stated interest in merging with biotech targets went public on US exchanges. Some are still active. RA’s own SPAC story began in early 2020, when we started off thinking that a certain caliber of SPAC could both outcompete other blank check companies as well as provide a more attractive option for a high-quality IPO-ready biotech. With a SPAC, investors essentially have an opt-out on the merger (as opposed to fighting to claw their way into a promising IPO alongside a horde of flippers and speculators). Assuming we could land the right deal, we figured enough of our peer investors would like it enough to put together the necessary PIPE.
So in July 2020, we priced the IPO for TXAC (later renamed RACA, which is now PNT, as we’ll explain below).
Since we would be competing with many SPACs, and since high-quality private biotechs would have their pick of the litter, we decided that ours would have to stand out. For starters, we only allocated shares in our SPAC IPO to high quality fundamental biotech investors who we believe think like we do. These are the funds you’d be very proud to IPO with, and so we figured this would be viewed as a credible path to the public markets.
In addition to pulling together the bluest of blue-chip investor bases, TXAC ended up being the first SPAC to ever go public without any warrants. Warrants give SPAC investors the right to buy additional SPAC shares at a fixed price, usually $11.50 (vs. $10.00 for a share in the SPAC). Since investors will only exercise their right to buy the warrants if the stock trades up above $11.50, investors see this as extra incentive to invest, though “target” companies can only count on this additional capital if their stock trades up after the merger, so those companies typically do not want warrants.
Warrantless SPAC IPO completed, it was time to go looking.
On the prowl
Once we were in the market looking for attractive targets to merge with our SPAC, here are some of the obstacles we encountered: some companies needed cash even faster than a SPAC would allow, so they had to do a crossover round; others had crossover investors already; those companies could easily IPO. We knew there had to be an edge case … a company without a straightforward path to a successful IPO that was nonetheless sufficiently capitalized that it wasn’t in a rush.
And we found one in a company called Point Biopharma, a radiopharmaceutical company with multiple clinical programs. What made Point a good candidate? Point did not have traditional crossover investors; it was a Canadian company that had not raised capital from what we might see as traditional pools of capital; and its last round’s post-money valuation made it a challenge to do both a crossover and an IPO if each were at a step up to the prior round’s valuation.
So Point needed to go straight to an IPO. But without crossover investors involved the company was unsure how they would be received by the public markets. The cash needs were such that our SPAC merger with a concurrent PIPE made sense for Point.
In March 2021, we announced that RACA would merge with Point Biopharma in a deal that would bring approximately $300M for Point, which included the cash in the SPAC account and the $165M PIPE.
At the time it was relatively straightforward to complete a SPAC merger, with several of our peers announcing deals around the same time. And the market was doing well enough that our peers mostly continued holding their Point shares.
The SPAC catch
But the bar for staying invested in the SPAC once it has found a target is low (again, investors in the SPAC who don’t want a stake in the merged company can redeem their shares for $10, which is what the shares are sold for in the IPO).
People hate missing out – until they see they aren’t missing out on a big spike in the price after a deal is announced, and then they can be tempted to sell. It’s … sloppy. Even the smartest biotech institutional investors can dabble, and the SPAC boom created conditions for turning smart specialists into dabblers, not investors. We bought more shares before and after the merger closed. We absorbed a lot of shares that were sold, but our interest was evident - we had been the main investors choosing the merger target in the first place, us and the few folks in the PIPE.
The SPAC worked well for Point Biopharma, which is now funded through several clinical-stage read-outs and has successfully built out their plant in Indianapolis. And we thought we would give it another go with a second SPAC, RACB, which IPO’d just a few weeks after we had announced the Point Biopharma merger.
The SPAC match
But the SPAC boom took place at a time when the biotech markets were thriving. In early 2021, the sector entered a prolonged downturn. In a more difficult capital environment for biotech, when IPOs are hard and private companies are doing down rounds, you would think a SPAC could be the perfect financing vehicle. It makes sense that many more biotechs would be crowded into that SPAC sweet spot that so few biotechs inhabited in 2020 and the earliest months of 2021.
But it turns out that SPACs - even warrantless SPACs - have downsides compared to other financing options, even during a downturn.
We’ve already mentioned how SPACs have a redemption feature that makes it easy for shareholders to opt out. That’s one factor.
Secondly, SPACs carry excess dilution, because the investment fund sponsoring the SPAC is treated like a founder. That sponsor-founder gets a bunch of common shares they bought at inception for less than a penny each. And some additional shares for funding the SPAC’s legal and finance costs that they bought for $10 each. Usually these “sponsor promote” shares wind up giving the SPAC sponsor >20% ownership for very little money down. They are valued at the SPAC’s share price, usually ~$10/share, once the SPAC IPOs. That’s potentially a nice sweetener for the investors in our funds, who received the “sponsor promote,” but not as nice for other investors.
And here’s the kicker: in a downturn, there are an increasing number of SPAC-like options for high-quality private biotechs. Those companies might like the concept of a SPAC, but would rather avoid a SPAC’s dilution and redemption-related uncertainty. So in those conditions, SPACs meet their match: public companies with cash on their balance sheets who have given up on their own R&D. These companies can offer a relatively clean shell in so-called reverse mergers.
So in a down market - particularly one where there are lots of shells - SPACs are at a disadvantage.
The more market conditions deteriorate and the more time goes by, the less you can count on a SPAC’s investors to not opt out. The more redemptions, the larger the PIPE the SPAC sponsor has to round up to make up for the investors who bailed.
Well, if new investors are going to participate in a giant PIPE, then they may as well do that at the same time as a reverse merger into a clean, low-cash shell, of which there are plenty, and not suffer the dilution of a SPAC sponsor’s shares or warrants.
SPAC skepticism
Any company that elects to go public via a SPAC merger at this point might be viewed skeptically, not unlike a company that goes public via a reverse merger when the markets are welcoming to new IPOs.
This doesn’t mean that such a company will fail; there are some great companies that had unconventional entries into the public markets. But it just means that most of the SPACs out there now labor under such adverse selection pressure that we no longer thought it made sense for us to continue to field our own SPAC or to continue to participate in others’.
We currently hold shares in three pre-merger SPACs and we have shared this thinking with our peers that sponsor them. Whether they elect to disband as well is up to them; we won’t bother selling our SPAC holdings at this time since they mostly trade below par. But we’ll probably be redeeming our shares for cash when the time comes and suspect, based on how we’ve seen others act, that most SPAC participants would redeem too, which is precisely why we think SPAC deals for high-quality companies are unlikely to happen in the current market environment.
Of course as with many rules, there have been some exceptions. For example, just last month, a SPAC led by Frazier Healthcare Partners closed a merger with the cardiovascular-focused biotech NewAmsterdam Pharma (which is based in The Netherlands, and so ought to be called OldAmsterdam, but we digress). About a third of that SPAC’s investors bowed out and redeemed their shares. We at RA joined some other specialist investors in the concurrent PIPE, which raised $235 million.
NewAmsterdam was a special situation that can be chalked up to the expertise and conviction of its sponsor and some investor queasiness around trying to resurrect the CETP drug class. As we see more high quality companies going public through reverse mergers into shells, we expect there will be even fewer exceptions. The market seems too efficient for that to happen as often as all the current SPAC sponsors would need it to.
And so that’s the end of our SPAC story, for now anyway. It’s not all bad. Was our second SPAC a failure? Yes, despite our best efforts, it didn’t find a merger target. But those who purchased in the IPO got to go home with the cash they put in – with the result that their investment in RACB dramatically outperformed the XBI.
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