NOEL BROWN: Hello, and welcome to another edition of Pathfinders, a podcast series from RBC Capital Markets that explores the fast-moving world of biotech and what the road ahead looks like for companies and investors in the sector.
I'm Noel Brown, Managing Director and Head of Biotechnology Investment Banking here at RBC. In this episode, we look at one of the biggest stories of today's IPO market, the biotech SPAC boom.
SPACs, or special purpose acquisition companies, existed on the fringes of the financial world until recently. But recently, their popularity has exploded, resulting in a 320% increase in the number of SPAC IPOs in 2020 compared to 2019. This boom shows no sign of slowing down in 2021. SPAC IPOs are continuing to accelerate at a record-breaking pace, particularly in the biotech sector, which raises key questions for investors, sponsors, and corporates in the year ahead.
So what's driving the SPAC boom? Is this a short-term craze or sustainable change? When is the SPAC the right or wrong choice for a biotech company choosing to go public? And what's next for this alternative transaction structure?
To help me connect all the dots on this topic, I'm joined by three of my colleagues, RBC Capital Markets' Co-Heads of SPAC Coverage, Amir Emami and Michael Ventura, and no stranger to the podcast, Jason Levitz, our Head of Healthcare Equity Capital Markets.
So, let's start with the fundamentals. Amir, what is a SPAC, and how does it work?
AMIR EMAMI: Thanks, Noel, and hello, everyone. So a SPAC, in the simplest terms, is a blank check company. And how does a SPAC actually work? Well, a SPAC sponsor group will go ahead and form or set up the formation of a SPAC entity itself. The SPAC entity raise capital in the public markets by selling units, which consist of a common share plus some fraction of a warrant.
Now, biotech-focused SPACs are a little bit unique in that there are several that are able to raise capital with just common shares only and do not offer warrants. But typically, a unit will consist of a common share plus a fraction of a warrant. And they will sell that unit to investors that will pay $10 for that unit.
That $10 is then taken and placed into a trust account that initially, up until a deal is announced, will effectively be a credit instrument because those investors have the ability to redeem their shares, their common shares, for their pro rata share of the cash and trust. So, they can actually get their $10 back plus interest at the time of a deal closing if they do not feel that it's an attractive deal for them.
And once a deal is announced, it will trade more like the company itself is already public. And what I say as well is that the reason these instruments have really gained in popularity is partially because of the downside protection that's in there, plus the embedded call option from both the warrants, as well as the option that comes with being able to stay in the transaction or redeem your shares for cash.
NOEL BROWN: What is fascinating to me is that we're experiencing one of the most robust biotech IPO markets in history, as Jason will attest to. So why not simply go public via a traditional IPO?
AMIR EMAMI: Well, a SPAC transaction offers a couple of distinct advantages. We'll talk about it generally, and then address the biotech industry specifically. A non-biotech company can achieve certain benefits by going public via SPAC, and these include the ability to market off of projections.
Keep in mind that a SPAC transaction is technically a merger, so the SPAC entity is public, and it's acquiring a private company. And when it does that, it files an S-4, which is different than an S-1. In the S-4, you're able to go ahead and include forward-looking numbers. And the management of the private company and the SPAC sponsor team are able to go ahead and talk about those projections freely.
That is different in a regular-way IPO process, where the management team will file an S-1. And the S-1 is a historical-looking document, so historical financials are there. And then they also provide projections, but the projections are provided to the research analyst community. And the research analyst community forms their own opinions and their own projections, and they'll be the ones that communicate their views of the company to public investors. So that's one difference, being able to go ahead and market off of your own projections.
The second difference is the process mechanics and the point at which you receive valuation certainty. So, in a regular-way IPO, you won't know the valuation until after the book building process. So you launch the IPO. You will have several days of marketing. You'll build up an order book. And then your advisors, your underwriters, will take a look at the order book. We'll see what the demand is, and we'll price the transaction based off of that demand.
In a SPAC transaction, you're effectively getting valuation certainty earlier in the process. And that's done through a combination of negotiating with the SPAC sponsor, with a market check or validation of the structure and valuation when you go out and try and raise the PIPE. so that's another big difference.
There are some timing differences. In some instances, a SPAC transaction can be quicker. And another difference is sometimes a SPAC sponsor can provide additional market credibility, or what we like to refer to as a halo effect. Because of their reputation, they're able to go ahead and provide additional validation to the company, as well as some benefits. And that SPAC sponsor group might actually also have operational expertise and can help the private company accelerate its growth or find new opportunities.
In the biotech space, specifically, one of the benefits can be the ability to compress the crossover round with the IPO into one step. A lot of the biotech-focused SPACs are raised by very prominent investors in crossover rounds. And instead of having a two-step process, you could potentially go ahead and compress it into one. But I'll turn it over to Jason for his thoughts as well.
JASON LEVITZ: Thanks, Amir. I guess I'd make a couple of points, and the first is to your comment about compressing the crossover to IPO path, because that's so well-trodden in biotech, as the listener group knows.
Roughly 80% of all biotech IPOs have what we'll call a crossover round ahead of the IPO. And because of those rounds, and because those investors typically anchor the IPO in the traditional route, there is, perhaps, a bit more valuation certainty, or at least visibility, around the IPO outcome than there might be for an IPO in another sector without a crossover and a fully-covered book at launch.
So I think that's one consideration to balance when you consider the traditional route versus the SPAC route.
The second is around validation. And it's no coincidence, if you look at the roughly 30 odd biotech-focused SPACs, many of them are sponsored by those same investors that lead crossover rounds and provide that third-party validation that a broader group of public investors are looking for. So, as you think about the traditional crossover to IPO path versus the SPAC path, one consideration obviously is the sponsor you're working with in the SPAC; their ability to drive a syndicate of demand around a potential PIPE; and providing that third-party validation and valuation visibility that you'll get as well, potentially, through the crossover to IPO path.
MICHAEL VENTURA: If I may jump in; it's Mike Ventura, I think Jason and Amir are highlighting two really critical points that we might have an opportunity to amplify here. You touched on just how hot the biotech IPO market is. Case in point, we're seeing folks who are drivers of that crossover capital start their own SPACs, effectively to amplify the economics that they can achieve being an anchor investor.
Obviously, the founder economics of a SPAC provide some unique benefits that, if you have expertise in a given discipline like biotech, can be really powerful. And they're using these vehicles to go out and make acquisitions. But it is an exceptionally competitive market from an institutional investor standpoint right now. And there are only so many ways to generate differentiated alpha in the marketplace. And SPAC PIPEs are a really unique way to be able to do that.
So I think for our institutional investor community, this has been a phenomenal opportunity to showcase their expertise in a given discipline; partner with both the SPAC sponsors and assets that are targets of SPACs, as Amir highlighted, via the PIPE process and the tri-party negotiation forum; and really end up effectively pricing an IPO of a very high-quality to a group of 20 or 30 institutional investors, versus the regular-way IPO process where you're competing for those same dollars with hundreds, if not more, of your institutional investor peers or competitors.
NOEL BROWN: So you've all raised some interesting points here, because one of the benefits that people market the concept of a SPAC with is a lesser level of dilution because you're not having to go through the crossover round dilution, and then on top of that, being diluted at the IPO level. But if I'm hearing you correctly, while you have that direct negotiation between target and sponsor-- and obviously, there's dilution in that transaction-- there potentially is additional dilution because I'm also layering on a PIPE. So, am I really avoiding dilution?
AMIR EMAMI: So what I would say to that, one, first and foremost, you have to take a look at each specific situation and determine what the valuation is at the crossover round phase, how much of a step-up you would get in the IPO, and factoring the IPO discount as well, to get the holistic view of what that transaction costs are, both direct cash out the door costs, as well as the implied costs from the discounts to valuation.
In a SPAC transaction, you obviously have the founder's shares, the founder's economics. And in some instances, you have warrants as well that are outstanding. Those are two different points of dilution that we need to factor in.
When it comes to the PIPE, the PIPE is coming in at $10 per share, which is where most SPACs are priced at and where they announce deals at. And that $10 is basically the equivalent of the value at which you would be going public at effectively.
So, there isn't any incremental dilution from that perspective. The PIPE investors are not coming into a discount. They're not coming in at a crossover value. They're coming in at the IPO transaction value. That's the way I think about it. But the other points of dilution are real. The founder shares are real.
So, you need to balance those various considerations
JASON LEVITZ: Maybe just to look at the other side of the coin, because while dilution is absolutely an important consideration, the other side is, is the company, in either path, funded to a point where they're well-positioned to execute on their pipeline in the public markets?
And if you think back to the more traditional alternative to an IPO, it was the reverse merger. And many of those companies, while completing successful transactions, were public market listed but didn't have the capital they needed. And a bit of an overhang around financing was created very quickly in the company's public life, whereas in the IPO process today, companies are typically very well-funded to the tune of, let's say, two to three years of cash post-IPO.
And as Amir mentioned, with the PIPE process, what we found in many of the SPAC transactions in biotech is these companies are also very well-funded, which positions them well from a public market standpoint. There's no financing overhang. They're well-funded with strong shareholder bases. So, I think while, certainly, a dilution in either path is an important consideration, just as important for companies in the sector is ensuring that the company is appropriately capitalized once it's in the public market.
NOEL BROWN: One thing that all three of you talked about is the timeline and the order of events, right? With a traditional IPO, if I analogize it to cooking, we go and gather a bunch of ingredients, lay them on a counter. We start mixing, stirring, cooking, and then we sit down to eat, which is the big roadshow ultimately leading to pricing; whereas with the SPAC, there seems to be a main course and dessert, and then we go back and do all the other tasks in almost a back-end loading of some of the heavy lifting with legal and accounting.
That timeline, though, with traditional IPOs does create a lot of market risk. Are we somehow saving ourselves from that with the SPAC?
AMIR EMAMI: I think from a timeline perspective, if the company is at a stage where it's about to start its S-1 drafting, and at the same time decides to launch a process to identify SPAC to go public with, to merge with, if that's the starting point then the SPAC timeline and the IPO timeline are basically right on top of each other from when you'll actually go ahead and close the transaction.
The difference is in the SPAC process, you'll get to a point of valuation certainty faster because what you are doing is, you're running a process, you're negotiating with the SPAC sponsor, you're raising the PIPE. And that can be done fairly quickly, and you'll lock in valuation certainty in sometimes as little as two to three months; whereas in the regular-way IPO, that valuation certainty isn't achieved until after you launch the IPO.
MICHAEL VENTURA: One thing I would add, I think, is the one aspect of the process that tends to get discounted, quite frankly. Over the course of the first, call it three to four quarters of life as the pro forma company, there really is quite a bit of institutional investor outreach that management should be focused on, IR, corporate access, really a high level of institutional engagement to really begin that ownership transformation from the mix of, again, SPAC IPO buyers, PIPE buyers, to something that looks much more akin to the publicly-traded comps.
I think that one aspect, the back-end work in terms of institutional shareholder engagement, is one that's worth highlighting.
AMIR EMAMI: One thing I also want to add to that is that's actually a positive in my mind. The greater level of institutional engagement from the time you announce a deal, going forward, enables companies to go ahead and more effectively tell their story directly. So you're able to build up a following in the public markets.
NOEL BROWN: Now, that raises an interesting question because through the traditional IPO, we've got a multi-day bookbuild that's really generated with the input of orders from hundreds of investors. And so you've got investors that are voting with their checkbooks leading up to their ultimate pricing; whereas with the SPAC, you're going on almost a campaign to ensure that those folks stay in the mix once the deal closes. Is that a fair way to think about it?
AMIR EMAMI:Yes with one added twist in the biotech space. So, in SPACs that are not biotech-focused, they're going to have a variety of investors in there, some of which might be natural holders of whatever the SPAC acquires, and some of which will not be.
In biotech SPACs, it's different because on day one, you know with a high degree of confidence, that a biotech SPAC is going to acquire biotech assets. So, on the front end of this SPAC IPO, you have investors who want to actually own biotech. So you already have the level of engagement.
NOEL BROWN: Those are all great points. Jason, one question that we get from CEOs, management teams broadly, across the board is what it takes to become a successful IPO candidate and then what it takes to be a successful SPAC. And frankly, I think we may have to disabuse people of the fact that the bar, the threshold of success, is not necessarily lower on the SPAC side because some companies will say, "Well, I'm not ready for an IPO, but I'm hearing a lot about these SPACs." So can you speak to what it takes to be successful?
JASON LEVITZ: Sure. I do think it's an important consideration that the best SPAC candidates are likely good IPO candidates as well.
I think that underpinning is extremely important to note because in biotech, it's less about stage of development, it's more about quality of science, path to proof of concept, ultimate market opportunity, third-party validation, et cetera. So I think those criteria are important to consider, irrespective of the path a company chooses.
The other benefits are the ones that I would suggest that companies focus on, i.e., time to market and valuation validation, particularly in a market that's as crowded as it is. But ultimately, you're right, Noel. I think most companies, if they're not ready to be public, most likely won't be particularly attractive candidates for a SPAC transaction.
MICHAEL VENTURA: I'm sure Amir and I are probably both trigger happy on our mute buttons right now, but, "The SPAC is not a panacea," is a common refrain that you'll hear from both of us. Very oftentimes, we hear from partners of ours, "I have a company that's looking at the SPAC market." And Jason touched upon this. "I have a company that's looking at these deals getting done in the SPAC world. They're probably a couple of years away from being IPO ready, but should we have a discussion?"
They'll be public in six months if they go down the SPAC route successfully. So, if they're really much further out, from a preparedness perspective, it's probably not a route they want to be necessarily thinking about. Always good to talk about, and always good to keep options open. But I think Jason really highlights the critical point, which is the companies should really, by and large, be ready for the public markets in most aspects of their business.
NOEL BROWN: Great points. I've always been a proponent of optionality yields the best results at the end of the day. And from what I'm hearing from all three of you, it seems that we're perhaps seeing the emergence of a tri-path process, as opposed to the typical dual paths of IPO and M&A that we used to have before. Is there now a third fork in the road?
AMIR EMAMI: Absolutely. And the way we think about it as well is you have multiple ways of becoming public, and you have multiple exit options. If it's a sponsor-owned asset, and they want to exit, they of course have the regular IPO market, they have an outright sale, and they also have the SPAC option. If it's a company focused solely on going public, and this may not necessarily apply to biotech companies, but more broadly, you now have regular-way IPO, SPAC option, and a direct listing. And having options is always a great thing. So are these SPACs here to stay? Is this a flash in the pan? Are we seeing the peak of one wave that will crest back down, and something else will come to replace it? Or what do you all think?
AMIR EMAMI: It's a great question. And what I would say is this. Just given the longevity of SPACs the product itself continues to evolve to make it better for not only the sponsors of SPACs, but also for companies looking to merge into SPACs, but also for public investors.
Is it perfect? No. I think it's a product that's going to continue to evolve. We're going to have high-caliber, high-quality sponsors continue to come out and want to improve it and reduce some of the friction costs. And it is because of that, I think it's going to go ahead and stay. Is it going to stay at this incredible pace that we've been witnessing? That, I don't know. Unfortunately, I wish I had a crystal ball to be able to tell whether the pace will continue or not, but we do think it is going to go ahead and stay. And it is a very attractive tool for certain situations. And it's an incredible tool, given how flexible it can be.
MICHAEL VENTURA: I would also just remind folks, in the last two years, we issued more SPAC IPO volume on a dollar basis than in the history of the market combined. It was just a stunning pace of issuance. And in the first six weeks of this year, we're averaging roughly $1 billion of SPAC IPOs a day.
So we're continuing on an incredible pace.
But to the point about crystal balls, I would keep in mind this is an exceptionally young market. And so I think the most formative chapters in the history of the SPAC market are likely to be written in the next 18 months. Whether those chapters are a comedy, a drama, a thriller, I think that remains to be seen. But certainly, there's going to be an incredible market transformation, in the types of assets that SPACs acquire, an increase in the provenance and quality of sponsors who continue to embrace the power of the vehicle, and hopefully continued high-quality M&A that comes out of it.
And if we have all of those ingredients come together, I think the market will remain very robust. Whether or not these issuance levels are sustainable, I think that's a big question mark. But certainly, I think the product has really cemented itself as a core capital markets tool and really one of the three core avenues for getting public, whether it be regular-way IPO, SPAC IPO, or direct listing.
NOEL BROWN: Great. Maybe one question, one last question, and then we'll have to put it maybe in a different order. But is the growth in just SPAC offerings a reflection of capital getting ahead of available companies to invest in?
MICHAEL VENTURA: think the explosion in SPAC IPO issuance really happened to coincide, not coincidentally, with obviously COVID. And I think a realization that the number of publicly-traded companies has been more than cut in half in the last 10 years, the world, and just given low rates and the broader market backdrop going back now to March of last year, was awash in capital.
Institutional investors obviously don't get compensated for keeping LP capital in cash. And so they needed a place to deploy that capital in the market that was perceived as relatively safe. I think we touched on the technical nuances that really set SPACs apart as an incredible cash management tool, the downside protection, the call option upside of the warrants.
Couple that with the incredible transformation of SPAC sponsors that were embracing the product, and the incredible reception of SPAC M&A, and the aftermarket performance of SPAC M&A, the alpha generation on the PIPE opportunities that I mentioned earlier; all of this comes together to really highlight the product as one that is an incredible place to deploy capital.
JASON LEVITZ: And maybe just to close, Noel, looking at the question through the biotech lens specifically. My guess is that the pace of new life sciences SPAC formation will probably slow a bit as the year progresses. We do expect the IPO calendar, in contrast, to be very heavy, so that balance will likely change a bit as the year progresses. But I think to the broader question, it certainly feels like there's still a good deal of interest on the investor side around new SPACs. And the transactions we're seeing on the back end, up to this point, seem to be quite well-received with successful PIPEs, so expect activity will continue to be busy on all fronts in the near term.
NOEL BROWN: That's a great closing thought. Thank you, Jason, Mike, Amir, for all your insights today. What else does 2021 have in store for the biotech industry? We'll be keeping track right here on Pathfinders. Until our next episode, thank you all for joining us. If there are any areas that we discussed that you'd like more information on, please don't hesitate to contact us directly for more in-depth discussion, or visit our website for further insights.
Disclaimer: This content is based on information available at the time it was recorded, and is for informational purposes only. It is not an offer to buy or sell, or a solicitation, and no recommendations are implied. It is outside the scope of this communication, to consider whether it is suitable for you, and your financial objectives. For disclosures, please visit www.rbccm.com/disclosure