Why some Spac deals are not all they’re cracked up to be

Health tech Spacs are back. After a May lull, two deals agreed in June and three in July means 18 medical device, diagnostics or digital health groups have moved to be merged into cash-shell companies so far this year.

A look at the companies whose Spac mergers have closed, however, reveals a less impressive track record. Of the 10 medtechs that fall into this cohort, all but two have seen their share price decline since the deals were announced, with the median loss being 20%. And five saw more than a third of the Spac’s investors redeem their shares, choosing not to remain shareholders in the target entity, something that is another signal of poor support for a deal. 

The large amount of money that can be raised via a Spac merger is frequently cited as an advantage versus traditional IPO. But this is only the case if redemptions do not drain the Spac’s trust account, although many companies are raising extra cash via a Pipe, to top up any shortfall. Participants in these Pipe rounds can be new investors, often active in sectors outside healthcare, such as IT or fintech. 

None of this is dampening the enthusiasm of the medtech entrepreneur Jonathan Rothberg. “You could raise $100m in an IPO,” he tells Evaluate Vantage. “But with a Spac you can raise half a billion.” Within the past year Mr Rothberg has sold no fewer than three of the many medtech companies he has founded to Spacs, and is a great proponent of the blank-cheque merger. 

His most recent announced deal concerned the sale of Hyperfine, which has an FDA-cleared portable MRI machine, and the vital sign monitoring company Liminal Sciences to Healthcor Catalio Acquisition Corp. Dr Rothberg founded Hyperfine and the incubator from which Liminal was spun out. 

Two other groups he founded, the portable ultrasound developer Butterfly Network and the proteomics specialist Quantum-Si, closed Spac deals this year. Counting the Pipe financing that accompanied the mergers, these did indeed raise in excess of $500m each. 

Raising a large amount of cash this way enables a medtech to develop both a platform technology and the applications, or consumable devices, to use with it. The disposable products – Butterfly’s software and Quantum-Si’s protein identification tests – have vastly higher margins than the machines that run them, allowing the groups to break even faster.

Redemption song

And this is important, because Spac deals are expensive, frequently costing the device maker three or four times as much as an IPO. And if redemptions threaten to take a big chunk out of the sum on the table, a company might end up with substantially less money than planned. That could make it a much riskier proposition for those shareholders that choose to stick around, and risk the whole deal collapsing.

In reality this does not appear to be happening. Four of the deals closed this year did so despite the Spacs’ shareholders redeeming more than half of the shares. 

A particularly alarming case is the acquisition of Owlet by Sandbridge Acquisition Corp, which saw holders of 19.8 million shares – around 86% of the Spac’s public shares at IPO – back out. This meant that just $32m was left in Sandbridge’s trust account. 

When the $130m from the concurrent Pipe round is added to this, and the usual transaction fees are deducted, Owlet scored just $136m, a far cry from the $360m the deal was intended to raise. Remarkably, Owlet waived the deal’s minimum cash condition of $140m; in some ways it is surprising that the stock is down just 1% since the buyer, Sandbridge Acquisition Corp, floated.

Nautilus Biotechnology, like Quantum-Si a proteomics company, managed to get its deal done without any of the Spac’s shareholders redeeming their stock. The share price of Arya Sciences Acquisition Corp III rocketed when the deal was announced, but has drifted since, and the stock now sits 22% lower than when the Spac listed.

Nautilus has taken what might be regarded as the typical route to a Spac deal: it was minding its own business and got pounced on. 

“We considered many routes; we actually had not been targeting a Spac,” says its founder and chief scientist, Parag Mallick. The group was mulling both a funding round and a possible IPO, he says, and had plenty of cash from a $76m series B round it had closed in May. 

As has been seen before, the promise of easily accessed capital – Arya’s trust was worth $150m and the deal encompassed a $200m Pipe – was a head-turner.

“We’ve been honestly resistant. We’d just finished a series B; we were good. There were a lot of Spacs out there, but many of them had deal terms that were complex, or they have warrants,” Mr Mallick says. “But the opportunity to go much, much faster was very enticing.”

Risks

Despite the shrinking valuations post-Spac companies are seeing, both Mr Rothberg and Mr Mallick believe that such deals will continue to happen. 

“We’re seeing, particularly in life sciences, that there are these large capital needs for pre-revenue companies,” says Mr Mallick. “And there is an appetite … it seems that there is investor interest that didn’t exist five or 10 years ago. I can easily see Spac deals becoming an important market segment.”

Still, investors would do well to keep in mind the risks inherent in these ventures. In a deal with a high proportion of redemptions, those who do remain shareholders are in danger of being left holding the bag, stuck with a high-risk, possibly pre-revenue company that might never break even. Throw a sliding post-merger valuation into the mix and some medtechs and their backers might find themselves wondering whether the up-front cash was worth it. 

For an analysis of biopharma Spac deals see our previous story: EQRX aims for biopharma Spac record.