Big Pharma continues its hunt for innovation, and with uncertain market and regulatory conditions, some life sciences companies may be feeling the pressure to make their M&A exit or need additional funding in this tight financial market to progress their core asset to a value inflection point. However, for those not ready to jump on the M&A bandwagon just yet, not finding the right M&A transactional fit, or needing a bit more runway to hit a substantial value milestone, there are several strategic alternatives to help raise capital, reduce cash burn, and streamline operations.
Spin-off and split-off transactions are options that provide companies with flexibility, while also keeping M&A or IPO exit opportunities open. But spin-offs can be structured in a variety of ways and are not a one-size-fits-all solution. This article assumes that the life sciences company has at least two differentiated assets, a core asset it seeks to advance, such as a drug for a large unmet indication in de-risked late stage development, and non-core assets that are non-essential to the strategic objectives of the company, such as early stage IP assets with an expensive and lengthy path to approval. Which is the “core asset” may depend on stage of R&D, market interest, costs to advance, or other considerations.
Traditional spin-off transactions may offer a much needed rebrand
A traditional spin-off transaction involves the company transferring select assets and liabilities to a new company (newco) and issuing newco shares to its existing shareholders. This structure is ideal when a company has non-core assets or diverging, distinct product lines that might otherwise divert the company’s focus, financial resources, or strategic direction. In the cases of life sciences companies, that could include a pharmaceutical company shifting away from rare condition treatments to focus on a mass market drug.
Offloading an asset or incompatible product line to a spin-off can eliminate competition for resources that might hold back core asset development, as well as help rebrand a product to attract new investors — particularly a product that lends itself to a single-product line investment like AI and rare diseases. Public markets often view the non-core assets as distractions and liabilities that take resources away from the primary assets because they do not align with the core business.
A second version of this strategy is for the company to sell select non-core assets to a third party. This allows the Company to use the proceeds to extend its runway and spend exclusively on the core programs.
Since IP assets are essential to spin-off success, it’s important to conduct a thorough valuation of the spin-off assets, ownership, and licenses. It is also crucial to ensure the appropriate transfer of IP assets to the new entity and safeguard any components essential for the original company’s ongoing operations by way of licenses back to the original company. There may be some additional hurdles to clear depending on the origins of the IP to be transferred. For example, if it was in-licensed, there may be a fee or consent needed.
In addition, a traditional spin-off requires careful consideration of whether there will be ongoing collaboration or a clean break between the two entities. Whether it involves R&D, personnel, or operational infrastructure, establishing agreements for licensing, collaboration, shared services, or transition services between the original entity and newco can ensure a seamless transition and signal to investors that the newco has the necessary infrastructure to thrive.
Partial spin-offs can keep the door open for potential upside
For companies not ready to fully divest a promising asset, a partial spin-off can offer additional flexibility. In a partial spin-off, the parent company transfers select assets and liabilities to the newco, while maintaining a partial ownership interest. The rest of newco’s ownership is either offered through an IPO or made available for further third-party investment (alone or mixed with the parent’s existing shareholders investing new proceeds).
By segregating a diverse pipeline in this manner, a company may be able to get investors targeting the specific indication who would not invest in the diverse IP portfolio.
This approach can allow for separation of asset classes, particularly if one has high IPO or investment potential. The company can then highlight and capitalize on the value of the asset class with greater market appeal or growth prospects to enhance investor interest. It also allows the parent company to raise capital while maintaining control, leaving the parent company the opportunity to exit later — with more potential upside. This upside is derived from any future appreciation in the value of the spun-off asset.
Some companies may also consider a simultaneous merger post-spinoff, which can facilitate an immediate exit for the parent. A simultaneous merger post-spinoff can be particularly advantageous, by allowing the parent company to capitalize on favorable market conditions, streamline the transition process, and swiftly reallocate resources to focus on core business objectives. This also lowers the antitrust concerns as the target drug is the only asset acquired, and the rest of the pipeline is spun-off which could make HSR (Hart-Scott-Rodino) review much smoother.
Split-offs may improve capital structure
Split-offs offer life sciences companies a strategic mechanism to manage capital structure while enhancing operational focus (and developmental spend). In a split-off, shareholders exchange their shares in the parent company for shares in the newco. This allows shareholders to align their investments with their specific investment goals. For example, investors may want to focus on the high-growth drug development segment of a business, rather than the broader company. It also helps address circumstances where segments of the business require varying degrees of capital allocation. This allows the company to efficiently direct resources to the specific needs of each business segment.
Unlike a traditional spin-off, a split-off can reduce the parent company’s share count, potentially giving its share valuation a boost. By narrowing the company’s focus and reducing shareholders, split-offs not only streamline operations, but also improve investor confidence and market positioning.
However, split-offs have their trade-offs. With any stock swap, there is a risk of arbitrage or imbalance between the parent and newco. The newly formed entity may also necessitate substantial financial investment to ensure its viability and attractiveness to the market.
Conclusion
The choices of spin-off or split-off structures for life sciences companies hinge on strategic and operational goals, market conditions, and regulatory pressures. Each approach requires careful consideration of business objectives and investor perceptions. Companies considering implementing either a traditional spin-off, partial spin-off, or split-off transaction should also consult with their tax advisors regarding the tax implications of such transaction, which can often involve a complex tax analysis.
Source: Reuters.com