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April 1, 2021

SPAC Attack: CT companies get in on blank-check merger rush

PHOTO | Butterfly Network Connecticut startup Butterfly Network, which makes a pocket-sized ultrasound machine, is going public through a special purpose acquisition company -- one of the hottest investment vehicles on Wall Street.
By Matt Pilon

A unique and relatively rapid pathway for companies to raise capital and get listed on a public stock exchange has seen a national resurgence, and Connecticut is getting in on the action.

In the past few months, three Connecticut-based private companies — all in the medical technology space — have announced merger deals with publicly-traded firms called “special purpose acquisition companies,” which also go by the catchier acronym “SPAC” or the synonymous “blank-check” company.

Initial public offerings by SPACs, which raise money from investors to go hunting for acquisition targets, have already surpassed their record 2020 totals, with 296 IPOs so far this year as of press time, totaling $95.8 billion in proceeds, according to SPACtrack.net, which counts more than 550 SPACs actively vetting targets.

Locally, the largest SPAC deal by value involves genomics-testing provider Sema4, which has added hundreds of jobs at its Stamford and Branford facilities since 2018 with the help of a $6 million state loan.

The other two SPAC mergers involve companies founded by Jonathan Rothberg, a pioneer in speedier DNA sequencing who is perhaps Connecticut’s most prolific scientist-entrepreneur.

His Butterfly Network makes a pocket-sized ultrasound machine, while Quantum-SI is developing a protein sequencing platform that promises to lead to better ways to diagnose and treat cancer and other diseases.

The combined value of the three local deals is nearly $5 billion and the companies are all being acquired by New York-based SPACs.

For the merged or acquired companies, experts say SPAC deals generally mean higher valuations, more certain pricing and access to greater amounts of capital, as well as a faster path to the market compared to a traditional initial public offering process (three to six months vs. one to two years).

With hundreds of SPACs hunting for acquisition targets across the country, and securities laws only giving them a limited amount of time to spend their capital or risk giving it back to investors, experts say the situation is creating intense demand, driving up valuations and leading some earlier-stage companies to go public.

Matt McCooe, CEO of quasi-public venture capital investor Connecticut Innovations, which holds stakes in both Quantum-SI and Sema4, said SPACs have been making overtures to a number of CI’s venture portfolio companies.

“There’s so much capital out there, it’s a feeding frenzy,” McCooe said. “From our perspective, it’s great for our portfolio companies because they’re raising a lot of money at very rich valuations.”

As a public venture investor, CI also cares about economic impact. McCooe said SPACs, which are shell companies with no other operations, are preferable to standard acquisitions in which an out-of-state company might buy a Connecticut firm and move some of its functions to a new location.

“In an IPO they tend to stay here,” he said.

William Fish, a Hartford partner at law firm Hinckley Allen, which has worked on several SPAC transactions in Massachusetts, said some of his Connecticut clients are sniffing out possible deals with blank-check companies, drawn by potentially higher valuations that allow companies to access more investor capital.

“Because SPACs seem to be driving up the revenue multiples, they are thinking ‘wow, maybe we shouldn't be waiting, let’s test the waters and see what kind of numbers we get,’ ” Fish said.

Many predict the high valuations will eventually lead to a market correction that will drive down some SPAC share prices, but it remains to be seen how individual companies might be impacted.

Even McCooe, who is bullish about CI’s specific SPAC holdings, sees it coming.

“SPACs will be subject to the whims of the public markets,” he said. “I think it’s fair to say SPAC stocks will be hurt in the next 12 to 24 months.”

While there are only a few SPAC deals in Connecticut, there are plenty of blank-check companies that have formed in the state, mainly in Fairfield County, a hub of private equity and hedge funds.

According to an analysis of U.S. Securities & Exchange Commission filings, there are at least 15 SPACs that have formed here in the past two years.

One is in New Haven. Thimble Point Acquisition Co. raised $240 million in a February IPO. The SPAC is tied to the Pritzker Vlock Family Office, which was founded by billionaire philanthropist and Hyatt hotel heir Karen Pritzker.

Growth path

David Ethridge, U.S. IPO services leader for Big Four accounting firm PwC, began to take note of growing SPAC transactions in 2019, which saw 60 deals and about $12 billion raised in total.

“To me at the time, that was kind of zany because it was five times what I’d ever experienced as a capital markets professional in the past,” Ethridge said.

Then came 2020, and the global COVID-19 pandemic. Major companies began pulling their earnings guidance as the future became impossible to predict. Meanwhile, interest rates plummeted and the government flooded the economy with stimulus money.

Amid that extreme uncertainty, SPACs offered investors what appeared to be a safer bet with more upside, Ethridge said.

That’s because investors can pull their capital if they ultimately dislike a SPAC’s acquisition target. SPAC investors are also largely making a bet on seasoned management teams.

“It was kind of the perfect product at the perfect time,” he said.

The dynamics that emerged in 2020 continue at an even stronger pace in 2021, with almost 300 SPAC IPOs already completed, compared to 248 in all of 2020.

“These are really historic numbers,” Ethridge said.

The deal flow — including from celebrities like Shaquille O’Neal and Alex Rodriguez who are advising or launching SPACs — has caught the attention of regulators.

In late March, Reuters reported the SEC had opened an inquiry into the SPAC boom, asking Wall Street banks about their dealings with SPACs and how underwriters are managing risks involved.

With many more SPAC stocks on the market, Ethridge said he will be watching how they perform.

In recent years, post-merger SPAC stocks have underperformed the overall IPO market, according to Greenwich-based Renaissance Capital.

“Let’s see how this plays out over time,” Ethridge said. “The hope from folks like me who are capital markets professionals is that you’ll have a product with a SPAC that’s more durable than it’s been in the past.”

Bioscience legend

Rothberg, a chemical and biomedical engineer, is a bioscience legend in his native state of Connecticut, having founded companies such as CuraGen, Ion Torrent and 454 Life Sciences, which eventually sold for a combined $609 million.

More recently, he has led his smart medical device accelerator, known as 4Catalyzer, which has birthed eight companies, including the recent SPAC merger targets Butterfly Network and Quantum-SI.

Those two companies grossed combined proceeds of more than $1.1 billion, which Rothberg said was likely more than they would have raised through the traditional IPO process, based on average results for similarly-sized firms.

Rothberg’s companies could have gone public through a traditional IPO, but he said that process would likely have raised less capital and meant slower growth.

It’s not all about money though, Rothberg said.

He also connected with SPACs formed by two experienced management teams — Glenview Capital Management and HighCape Capital.

“In business, you try to find someone that complements you, accelerates your ability to work in parallel and it doesn’t matter that there are 550 SPACs out there, you have to find the one that is right for your problem,” he said. “SPACs right now are the best access to capital when there is a partner that has the skills you don’t, has access to customers you don’t have, or has the right executive team.”

Rothberg said two other companies in his 4Catalyzer accelerator — bedside MRI developer Hyperfine and brain-monitoring technology maker Liminal — could be future SPAC targets.

A SPAC sponsor’s perspective

Kevin Rakin, a partner at New York-based growth equity fund HighCape and CEO of its SPAC merging with Quantum-SI, has been in the Connecticut entrepreneurial scene for years.

He is actually based in Fairfield County and sits on Connecticut Innovations’ bioscience investment fund board of directors.

His history with CI goes back to the 1990s when the agency invested in his first startup, New Haven-based Genaissance Pharmaceuticals.

“Connecticut is a great pond to go fishing in,” Rakin said in a recent interview.

Today, CI has a stake in HighCape through a $3 million investment in a relatively new fund.

At the time HighCape was raising the fund, a SPAC wasn’t the intent, Rakin recalled.

“It’s funny, we’re not really trend guys or momentum guys,” Rakin said of his firm. “Our idea is you build a quality firm and you will achieve an exit.”

However, once Rakin and his team got more familiar with SPACs, they saw lots to like.

For example, after the SPAC IPO, they could corral a complementary pool of capital from big investors, known as a private investment in public equity (PIPE) round.

Rakin’s team was also used to investing in earlier-stage companies and a SPAC gives them the chance to shepherd a firm through an IPO process and further into its life cycle.

Rakin said he’s known Rothberg for more than 20 years. HighCape could have invested in an IPO, had Quantum-SI gone that route, but the SPAC structure provided an opportunity for Rakin to get more directly into business with someone he greatly admires.

“Jonathan is a genius who understands the entrepreneurial life sciences world,” Rakin said.

Before teaming with Rothberg, Rakin said he and his team vetted more than 40 companies to varying degrees, and saw firsthand the demand that’s being created by having so many SPACs on the hunt.

“We saw signs of an overheating SPAC market,” he said.

In fact, HighCape had a draft letter of intent to merge with a different company when another SPAC swooped in with a larger offer.

“I was shocked at the valuation,” he recalled. “I said ‘I can’t do it, we haven’t even done the due diligence yet.’ ”

Rakin is among those who suspects there will be a drop in SPAC valuations at some point, but he thinks the deals will stick around for the long haul to some extent.

“I think it’s an instrument that’s here to stay for the right kind of investor, which I think HighCape is,” he said.

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