Biotech SPAC combinations will continue to grow in count in 2022.
Rationale: The special purpose acquisition company (SPAC) route to accessing public market capital is not a panacea suitable for all types of companies; yet, we believe that for many VC-backed biotech companies, it may prove to be an advantageous financing vehicle over the traditional IPO process. Biotech & pharma VC deal activity exploded in 2021, notching a record-shattering $36.3 billion as of December 1 according to PitchBook Analysts. This, in turn, has driven valuations to dizzying heights and allowed VC-backed biotech companies to access public market capital earlier in their drug development lifecycles than ever before. Given the long-time horizons involved with drug development and clinical testing, the overwhelming majority of biotech companies are nonrevenue generating when they go public. Thus, SPACs offer two key advantages for biotech companies: First, drug revenue forecasting and projections are permitted during the business combination process (or de-SPAC), and second, SPACs can minimize the dilution that occurs during the traditional IPO process, during which biotech companies typically raise a crossover financing round in addition to the IPO round.
Potential headwinds exist on both the SPAC regulatory side and the drug pricing side. On the former front, Securities and Exchange Commission (SEC) Chairman Gensler has been a vocal critic of SPACs over the last year and has pledged tougher regulatory scrutiny.
Indeed, SPAC issuance has ground to a halt in H2 2021 given the increased uncertainty plaguing sponsors and the oversupply of SPAC vehicles compared with viable business combinations. On the latter front, President Biden’s latest legislative agendas have put the topic of drug pricing back in the crosshairs again. The latest roughly $2 trillion social spending and climate bill (that has yet to be approved by the Senate as of the time of writing) gives negotiation power to the government to reduce prices of some higher-cost medicines covered by Medicare and institutes an annual drug price cap at the rate of inflation—both of which are likely to put downward pressure on drug company valuations.
We have noted in past research notes that healthcare & life sciences is one particular industry that benefits the most from considering the SPAC route over the traditional IPO process when accessing public market capital. The record level of capital investment that poured into VC-backed biotech companies in 2021, coupled with the sky-high valuations that accompanied these private financing rounds, have allowed biotech companies to access public market capital earlier in their drug development and company lifecycles than ever before. Because these companies are overwhelmingly pre-revenue, access to public markets is realistically the only way for companies to fund trials in multiple clinical indications and research & development (R&D) programs for various drug candidates, given the holding times for a successful go-to-market strategy and the dedicated capital pool. The VC-backed IPO index is not specific to biotechnology and contains a variety of different industry subsectors. Our team’s latest SPAC research note from Q3 2021 indicates that the recent lackluster aftermarket performance for SPACs could further dampen new issuance and general enthusiasm for the product. Yet, we believe that VC backed biotech companies will continue to utilize SPAC combinations as a viable exit route to act as a pressure release valve from the buildup of private capital and allow for liquidity to be returned to early investors. As of December 1, 2021, 32 new SPAC vehicles have been issued, with a biotech industry preference, raising a total of $7.3 billion. On the de-SPAC side, there have been 19 business combinations with VC-backed biotech companies, totaling an exit value of $13.1 billion. One point to note is while we have found that most biotech SPAC combinations are executed by sponsors with extensive biotech industry knowledge, any SPAC could feasibly bring a biotech company public, not only those with a biotech industry preference, which further increases the pool of potential SPACs gunning for biotech targets. Two notable biotech SPAC deals occurred in September 2021: First, Ginkgo Bio works (NYSE: DNA) combined with Soaring Eagle Acquisition with $1.7 billion in proceeds and a $15.0 billion pre-money valuation, making it the fourth-largest SPAC combination of the year regardless of industry; second, Roivant Sciences (NASDAQ: ROIV) combined with Montes Archimedes Acquisition with $411.0 million in proceeds and a $6.9 billion pre-money valuation. Furthermore, public market performance of VC-backed IPOs will also play a role in influencing whether VC-backed biotech companies decide to go public via SPAC or not. PitchBook’s latest VC-backed IPO index shows that, on a short-term basis, VC-backed IPOs in 2021 have significantly underperformed the S&P 500.1 While on a long-term basis, the VC backed IPO index outperforms the S&P 500 when normalized to the index’s inception in 2010, biotech companies need cash to maintain their runway, and short-term post-market volatility can damage the financial underpinnings of a biotech company. Additionally, biotech stocks have been getting hammered over the last several months, with the equal-weighted SPDR S&P Biotech ETF (XBI) and the cap-weighted iShares Nasdaq Biotechnology ETF (IBB) drastically underperforming the S&P 500 in YTD 2021. All these factors lead us to believe that an increasing number of VC backed biotech companies will go public via the SPAC route, allowing them to avoid the performance pressures and crossover round dilution of the traditional IPO process.