General Trends in Life Sciences M&A
If 2019 was the year of life sciences mega-deals, 2020 was the year of COVID-19, as the global pandemic permeated every aspect of the dealmaking landscape, with the life sciences sector being no exception. COVID-19 drove unprecedented levels of collaboration among biopharmaceutical companies seeking to develop a vaccine, leading to an accelerated research and development process that allowed not just one—but two—vaccines to be approved by the FDA in record-breaking time. In contrast, aggregate M&A deal value for the life sciences sector was down nearly 50% when compared to 2019, with the first half of 2020 particularly dismal in the wake of market uncertainty caused by the pandemic. The second half of the year witnessed a rebound spurred by several multibillion-dollar deals, including Gilead’s acquisition of Immunomedics for nearly $21 billion and AstraZeneca’s proposed acquisition of Alexion Pharmaceuticals for $39 billion. While deal value was down for the year, deal volume was relatively stable (down only 2.0% when compared to 2019), as companies with strong balance sheets sought opportunistically to buy distressed targets or shelved/non-core products, or took the opportunity to build product pipelines.
An Evolving Transactional Landscape
Increased collaboration among biopharmaceutical companies provided a silver lining in an otherwise bleak 2020, as parties worked together at unprecedented speed to develop a COVID-19 vaccine. Merck’s focus on the development of vaccine candidates led to its acquisition of Themis, and its collaboration with IAVI and Ridgeback Therapeutics, all within a few months, while the Pfizer-BioNTech collaboration brought the first COVID-19 vaccine to market. Similarly, many of the diagnostic tests developed to detect the presence of SARS-CoV-2 were the product of collaboration. This increasing level of collaboration may well continue, as life sciences companies seek to address mounting research and development costs and look to leverage efficiencies through partnerships to bring products to market on a more accelerated timeline.
Divestitures, often achieved through asset sales, were also popular in 2020 as large pharmaceutical companies and biotechnology companies sought to divest noncore assets and focus on core businesses in the wake of economic uncertainty created by the pandemic. These transactions are often more complex than larger public deals, and that complexity was only compounded by the pandemic, as buyers typically had minimal options for inspecting facilities and limited access to physical records sometimes housed in shuttered offices. Acquiring a single asset or group of related assets in a divestiture transaction (often referred to as a “carve-out” transaction) has traditionally been a headache for public company buyers who were required to provide full carve-out financials for the acquired “business” (even though the seller did not maintain standalone financials for that “business”). Fortunately, in May 2020, the SEC adopted amendments to the financial disclosure requirements that alleviated some of the burden for public company buyers in those transactions by permitting the use of abbreviated financial statements without the need to seek exemptive relief, as discussed in more detail in our previous blog post.
COVID-19’s Impact on Pre-Pandemic Deals and Future Dealmaking
By the end of Q1, the market’s attention was focused on how COVID-19 – and related measures adopted by governmental bodies worldwide – would affect pending M&A deals that were signed up before the onset of the pandemic. While there were a few high-profile examples of buyers in industries severely affected by COVID-19 (think hotel, travel and leisure, and real property deals) trying to terminate pending transactions, as well as ensuing deal litigation, a number of those suits settled before trial. Notable examples in the life sciences industry included Montagu Private Equity’s acquisition of RTI Surgical Holdings’ OEM business, which eventually closed in July 2020, but only after the parties amended their January 2020 purchase agreement to, among other things, reduce the purchase price and extend the outside date for closing. Also impacted was Thermo Fisher’s attempted acquisition of Qiagen through a tender offer launched on March 3, 2020. The initial offer for €39 per share was not well received by Qiagen shareholders, who believed that Qiagen’s equity was worth substantially more than the offered price due to the company’s involvement in the development of COVID-19 tests and related products. Even after Thermo Fisher raised its price to €43 per share, the tender offer failed and Qiagen’s stock has continued to trade above the offered price since the offer terminated in mid-August 2020.
While litigation tended to be the exception rather than the rule for transactions at risk because of COVID-19, valuable lessons were learned from the disputes that did go to court, causing transactional parties in all industries to re-evaluate the allocation of systemic risk in general, and COVID-19 in particular.
Earnouts Remain Popular – and Difficult
Earnouts continue to be popular methods for addressing valuation uncertainty, particularly in the life sciences space. As we have previously observed, the use of milestone-based earnouts to bridge a valuation gap is often a short-term solution that presents many long-term complications. In October 2020, the representative of the former shareholders of surgical robotics company Auris Health filed suit against Johnson & Johnson in connection with the $5.7 billion deal inked in 2019 that included more than $2 billion in contingent payments based on the achievement of certain milestones. The Auris shareholders argue that J&J never intended to make the milestone payments. The complaint alleges that J&J interfered with the achievement of the milestones by transferring employees from another robotics company acquired by J&J into the Auris unit who slowed down development, refusing expansion requests and slow-walking efforts to obtain FDA approvals. Not surprisingly, the parties appear to disagree over whether “commercially reasonable efforts” were used in connection with attempting to achieve the milestones as required by the merger agreement.
Life Sciences Enters the SPAC Party, But Will Reverse Merger Suitors Join In?
2020 was also the year of the SPACraze, with SPAC IPOs raising more than $75 billion in gross proceeds, a 525% increase compared to 2019. A confluence of factors likely attributed to this rise in SPACtivity, but there’s no doubt that the market uncertainty created by COVID-19 made SPACs more attractive options for some companies seeking to go public while avoiding the potential pitfalls of pricing an IPO in volatile environment.
The life sciences sector was slower than other industries to get swept up in the frenzy, partly due to the size of recent SPACs – the average SPAC trust size increased by nearly 50% in 2020 compared to 2019, to approximately $337 million. This presented challenges to some potential SPAC transactions in the sector, given that pre-market life sciences companies tend to be early-stage, pre-revenue companies with more limited immediate funding needs relative to the capital many SPACs are seeking to deploy. Notably, Q4 2020, which saw a significant surge in SPAC IPO activity (more than half of the SPACs that went public in 2020 did so in Q4) also witnessed a number of smaller-value SPACs, with the average SPAC trust size in Q4 decreasing by nearly 30% (to just under $300 million) compared to the previous quarter. This may signal a promising development for early-stage life sciences companies seeking to go public in 2021. And of course, not all life sciences companies seeking to go public are unable to support a significant valuation (see Nuvation Bio’s SPAC transaction with Panacea Acquisition Corp and Celularity’s SPAC transaction with GX Acquisition Corp, both reflecting valuations well over $1 billion).
Before the SPACraze, reverse mergers were often the only viable option for early-stage life sciences companies seeking to go public. As we discussed in our “SPACs!” webinar in fall 2020, reverse mergers and SPACS are structurally similar (in both, a private target goes public through a merger with an existing public company), but while a SPAC is blank-check company formed specifically to acquire a private target, a reverse merger typically involves an operating public life sciences company with a failed product or business. Unlike a SPAC, the reverse merger shell may have significant existing and/or contingent liabilities, some modest products or assets, a seasoned public company management team, and/or a more appropriate amount of cash on the balance sheet compared to the typical SPAC trust account. Although reverse mergers present additional issues relative to SPACs, such as the assumption of unknown liabilities from the failed operations of the public “acquirer”, we expect many life sciences companies whose interest has been piqued by SPACs to begin looking to potential reverse merger partners as a more suitable conduit to the public markets, particularly if the recent downward trend in SPAC trust sizes does not hold.
Because of the surge in SPAC activity in Q4, the increasingly broad range of SPAC size and industry focus, the fact that 204 of the 247 SPACs that went public in 2020 are still searching for a target, and renewed interest across the sector in alternative paths to the public markets, we expect to see more early-stage life sciences companies going public by way of a SPAC or reverse merger in 2021.
Governance and Activism
Following the onset of the pandemic, we noted that the COVID-19 era could usher in the return of the poison pill for some companies experiencing extreme volatility. Indeed, there were a number of new pills adopted in the first half of 2020, particularly in industries that were especially vulnerable to the impacts of the COVID-19 outbreak, but also in the life sciences industry (for example, Neuronetics, Biospecifics Technologies Corp. and Evofem Biosciences Inc., each in March and April 2020). Despite the initial concern, fear of increased activism never materialized on a large scale. Instead, many companies used the uncertainty created by COVID-19 to evaluate their long-term strategy for dealing with activists, whether by putting a rights plan on the shelf, getting a refresher on fiduciary duties in response to activism threats, or re-assessing their strategy for effective shareholder communications.
While activism activity overall was down in 2020, there were a few significant campaigns in the life sciences space, though the most significant campaigns appeared to be those that were initiated with respect to investments made before the COVID-19 outbreak. With the pandemic causing development timetables to slow – or, in many cases, grind to a halt – for some companies in the industry, and many life sciences companies being forced to raise capital in turbulent markets to support a public company infrastructure through the pandemic for a small number of (stalled) products, we expect the industry’s relative immunity to activism to begin to wear off in 2021.
Looking Ahead to 2021
We predicted in 2019 that the US presidential elections, Brexit and increased regulatory scrutiny would add uncertainty to the life sciences M&A market in 2020. Obviously, 2020 had other plans. COVID-19, along with broad social and political unrest in the US, became the primary driver of uncertainty in the M&A market broadly, and in the life sciences space specifically. While we expect this uncertainty to continue into 2021, the uptick in deal activity through the second half of 2020, coupled with a renewed focus on pre-pandemic strategic priorities, may be signaling a return to a more stable M&A market. Potential collaboration strategies coming out of the pandemic, along with acquirers looking to buy later-stage development assets rather than build to reduce research and development risk and speed up development timelines, and the number of SPACs still searching for a target, may also have a positive impact on the 2021 life sciences M&A market. However, the ability of life sciences companies to go public and to access public capital on relatively favorable terms may continue to serve as a short-term counterweight to M&A, by allowing companies to advance the development of their product portfolios and build commercial infrastructures while remaining independent entities. In addition, commercial-stage public companies with a single commercial product may remain vulnerable to takeovers, activism or other pressures because of the inability to efficiently deploy their commercial infrastructure, which may continue to fuel some level of industry consolidation.
 For the deals that did go to (virtual) court, buyers seeking to terminate transactions commonly alleged that the pandemic had caused an MAE on the target’s business and/or that target’s actions in response to the pandemic constituted a breach of the conduct of business covenant. On November 30, 2020, the Delaware Chancery Court analyzed those claims for the first time in AB Stable VIII LLC v MAPS Hotels and Resorts One LLC, et al., finding that the buyer was permitted to terminate a $5.8 billion hotel deal as a result of actions taken by the target in response to the pandemic, as those actions breached the conduct of business covenant. Despite the decimating impact of COVID-19 on the hotel business, no MAE was found due to a carve-out in the definition for calamities.