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SPAC Investing: Strong fundamentals will prevail

January 6, 2022
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SPAC Investing: Strong fundamentals will prevail

Last year was a boom year for SPAC deals, but public equity markets have been rocky since the beginning of 2022. There are numerous headwinds for SPACs, including a PIPE market in hibernation, high redemption rates and many SPACs trading down. SPAC investor interest is waning. Times are extremely tough right now for SPACs searching for targets, and many deals have failed to reach fruition.  

We are fortunate to have found Scilex, a biotech company with strong fundamentals, an approved product generating revenue and excellent Phase III data, as our SPAC target. The biotech sector saw a record year in 2021, with more than 100 biotech companies IPO, raising nearly $15 billion in funds. The highest IPO valuations went to companies with preclinical technology platforms that had broad potential. However, these companies tended to be still far away from clinical testing or marketing products, creating a disconnect between their market capitalization and actual worth. Many of the companies that went public last year have since lost significant value. Stock prices have tumbled and many now even have an enterprise value trading “below cash”. This has led to much introspection within the investment community on the future of biotech IPOs. (BiopharmaDive: Outlook on Biotech IPOs)

Despite this, there are some green shoots in the markets. Just recently, three biotech companies, Ascendis Pharma (drug-delivery platform), Argenx (biologics for autoimmune diseases) and Apellis Pharmaceuticals (peptide drugs for modulating the complement cascade), raised more than $1.5 billion after revealing positive data in Phase III clinical trials. (Endpoint News Article) Their success suggests that despite the tough capital market conditions, companies with good technology and data can still raise significant capital.  It is thus imperative for investors to dig deep into the fundamentals of the company and scrutinize development plans closely. Even more so now, as the SEC is proposing new rules to exclude SPACs from relying on "safe harbor" provisions to use forward-looking financial projections (New York Times: SEC propose changes to SPAC rules).

SPACs can still be a viable alternative to traditional IPOs for investors, target companies, and sponsors. For SPAC investors, there is limited downside risk as the funds are placed in a trust, which can be redeemed at the investors’ option. For companies, a SPAC merger may offer a cheaper and faster alternative to go public by coupling crossover and IPO financing into a single deal and establishing a company valuation early in the process. For sponsors, a successful de-SPAC is structurally designed to have a strongly mitigated downside with potential for attractive multiples coming from the sponsor promote and warrants. 2022 may be a tough year for SPACs, but 54 SPACs have raised US$10 billion this year to-date which puts 2022 on track to be 3 times that of 2019, which only saw $13.6 billion raised in 59 SPACs in the whole year.

The key to a successful SPAC is to identify the right target to merge with. Scilex's novel non-opioid medications have the potential to transform pain care for millions, helping us achieve our goal of doing good while doing well.

While it’s hard to predict short-term public market fluctuations, we believe that in the longer term, companies with strong fundamentals will prevail and create value, whether they merge with SPACs or go for IPO.

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