Ligand ‘Anchored Spin-Off’ Is SPAC Variation on Sponsored Spin

By Stuart E. Leblang, Michael J. Kliegman and Amy S. Elliott

Ligand ‘Anchored Spin-Off’ Is SPAC Variation on Sponsored Spin

If a sponsored spin ¹ and a Reverse Morris Trust ² had a baby, it might look like the proposed spin- off/SPAC merger recently announced by Ligand Pharmaceuticals Incorporated (NASDAQ:  LGND) (Ligand).  Specifically, on March 23, the company announced its plan to spin off its antibody discovery business subsidiary OmniAb, Inc. (OmniAb) to its shareholders, followed by an immediate merger with a wholly owned subsidiary of Avista Public Acquisition Corp. II (NASDAQ:  AHPA) (APAC), a publicly traded special purpose acquisition company (SPAC). ³ The spin-off and merger are intended to be tax-free to Ligand and its shareholders.  Avista Capital Partners (Avista), APAC’s private equity sponsor, will invest additional cash in the post-merger company, which is expected to be listed on NASDAQ under the ticker symbol “OABI.” Ligand shareholders will own between 75 percent and 84 percent of the post-merger company, depending on redemptions by SPAC shareholders.

This follows Ligand’s previous announcement in November 2021 of plans for a stand-alone spin- off, preceded by a public offering of less than 20 percent of its OmniAb business. ⁴ 

The core tax components of the transaction are relatively straightforward.  What we find noteworthy are the corporate finance aspects of the transaction, which essentially combine useful qualities of a pre-spin IPO and a sponsored spin transaction, updated to the SPAC world.  This transaction provides two helpful benefits that a straight spin-off may not:  establishing a value for the Spinco prior to the spin, and obtaining an anchor investor that can be helpful in certain circumstances.  We do not purport to know the precise set of considerations or motivations that influenced Ligand to choose the SPAC RMT approach, and our comments below are of a more generic nature.

It is not unusual for a public company that has decided to divest of a business to pursue a strategy of a spin-off to shareholders parallel to an M&A process.  This was the case when the top U.S. corporate tax rate was 35 percent and remains the case when the tax rate on resulting corporate gain from a taxable transaction now only tops out at 21 percent.  Apart from the fact that a sale can directly bring cash into the company’s coffers (which can only partly be done in a spin-off), a well-executed M&A process offers advantages relative to a straight spin-off.

For one thing, actually carving out a business and establishing it as a viable stand-alone public company can often be a big challenge and is one reason these transactions take so long to execute.  From the standpoint of an alternative M&A transaction, a strategic buyer most directly addresses this concern, particularly where it might be difficult to put in place senior management for the Spinco ⁵ or there are other challenges for a stand-alone Spinco.  But the right financial sponsor—likely not one chosen solely on the basis of the highest bid—can address much of this area of concern, applying the experience of building a stand-alone company out of a carve-out situation, often with industry-specific experience and relationships.

Second, whereas it is ultimately only an educated guess in what price range a newly public Spinco’s stock will trade, an M&A auction by its very nature serves to establish a negotiated price for the business resulting from a competitive bidding process.  A pre-spin IPO of a Spinco, as was originally planned for OmniAb, can at least establish a market in the stock before the spin-off occurs, and the IPO process itself provides a better opportunity than a simple distribution of shares to pitch the company to the market.⁶ In several cases, having established a public market in Spinco, parent companies have executed a non pro rata split-off of Spinco to shareholders using a Dutch auction or similar exchange offer, which effectively “sell” Spinco stock to shareholders in exchange for their stock in the parent company.  It is unclear whether Ligand had such a transaction in mind.  A drawback of the pre-spin IPO is that, generally, in order to be able to satisfy the tax-free spin-off requirement to distribute 80 percent “control” in Spinco, no more than 20 percent of Spinco can be sold in the IPO. ⁷ 

The classic Morris Trust transaction largely addressed both issues in appropriate cases.  Prior to the 1997 enactment of the “anti-Morris Trust” rule of Section 355(e), these transactions always involved a strategic acquirer.  Since then, the universe of potential merger partners is necessarily extremely limited due to the requirement that the shareholders of the acquiring corporation must own less than 50 percent of the post-merger company.

Where a financial sponsor rather than a strategic acquirer is involved, efforts to marry an M&A auction to a tax-free spin have focused on the sponsored spin transaction.  The details vary, but these generally involve a tax-free spin-off followed by a prearranged infusion of cash into a leveraged Spinco by a private equity sponsor in exchange for a less-than-50-percent interest in Spinco.  These have been far more commonly considered than executed, but one example is a 2006 transaction in which Alberto-Culver Company (NYSE:  ACV) spun off Sally Beauty Company, with Clayton, Dubilier & Rice acquiring a 47.5 percent interest in Sally Beauty. ⁸ Another example is a 2007 transaction involving Metavante Corporation’s spin-off of Marshall & Ilsley Corporation (NYSE:  MI) with Warburg Pincus acquiring approximately 25 percent of Marshall Ilsley. ⁹ 

A sponsored spin may be viewed as a leveraged buyout of a corporate subsidiary, with a 51-percent interest in the subsidiary being distributed to shareholders on a tax-free basis.  While there is no way to know how the stock of Spinco will trade, the spin-off will occur in the context of a negotiated “price” between the parent and the PE sponsor, likely after some sort of competitive auction process.  Viewed from the perspective of a spin-off transaction, the PE sponsor in such cases plays a useful role as an anchor investor in much the same way a quality PE sponsor does in a classic leveraged buyout transaction.  From the sponsor’s standpoint, presumably owning a 49 percent interest in the public company provides an adequate degree of practical control, and while a cautious approach is warranted, the Section 355(e) anti-Morris Trust rules do not preclude the possibility of purchasing more stock in the public market if and when it might be necessary to acquire full majority ownership.

Coming back to the Ligand transaction, it is structured as a so-called Reverse Morris Trust (RMT) in which Spinco’s merger partner is a SPAC.  We do not know but would guess that, given the competitiveness among SPACs for good deals, Ligand went through some sort of competitive process before centering on APAC as a merger partner.  In this scenario, the SPAC may be viewed as providing (1) equity capital, (2) stewardship from the PE sponsor behind the SPAC, and (3) a pretty good indication of how the post-merger company will trade based on trading in the SPAC’s stock after announcement of the transaction.

^{[1] In general, a sponsored spin transaction occurs when a financial sponsor invests in equity (often in Spinco) or debt around the time of the spin, with Remainco keeping some or all of the proceeds from the investment.}

^{[2] A Reverse Morris Trust (RMT) transaction generally occurs when a tax-free spin-off is preceded or followed by a pre-arranged tax-free merger.  In the latter case, under Internal Revenue Code §355(e)(2)(A)(ii), such a transaction is only tax-free at the spin- off stage as long as distributing corporation shareholders end up retaining more than 50% of the post-merger company.}

^{[3] Joint Press Release, Ligand and APAC, Ligand to Spin-Off its OmniAb Business Through Merger with Avista Public Acquisition Corp. II (March 23, 2022) (https://www.sec.gov/Archives/edgar/data/886163/000119312522082890/d341975dex991.htm).}

^{[4] Press Release, Ligand, Ligand Pursuing Plans for Omninab to Become a Standalone Public Company (Nov. 9, 2021) (https://investor.ligand.com/press-releases/detail/454/ligand-pursuing-plans-for-omniab-to-become-a-standalone).}

^{[5] Senior management does not seem to be a problem in this case, where the plan is for Ligand President Matt Foehr to lead OmniAb as CEO.}

^{[6] Examples of pre-spin IPOs are the 2011 IPO of 16.6% of Sunoco Inc.’s (NYSE:  SUN) SunCoke Energy, Inc. subsidiary (NYSE:  SXC) (https://www.suncoke.com/English/newsroom/press-releases/press-release-details/2011/SunCoke-Energy-Inc-Announces- Pricing-of-Its-Initial-Public-Offering/default.aspx) and the 2014 pre-split-off IPO of 15% of GE (NYSE:  GE) subsidiary Synchrony Financial (NYSE:  SYF) (https://www.ge.com/news/reports/ge-completes-the-separation-of-synchrony-financial).}

^{[7] It is possible to satisfy the Internal Revenue Code §355 control requirement by setting up Spinco’s capital structure with high- vote and low-vote stock such that the IPO could involve more than 20 percent of Spinco’s outstanding stock with less than 20% of the vote.  See, for example the 2006 tax-free split-off by McDonald’s Corporation of Chipotle Mexican Grill, Inc.  However, this leaves Spinco with this two-class share structure, generally frowned on by public markets (albeit used where control is deliberately concentrated in a single individual or group).  (See 2009 dual-class unwind by Chipotle:  https://www.sec.gov/Archives/edgar/data/1058090/000119312509259436/dex991.htm.)}

^{[8] https://www.sec.gov/Archives/edgar/data/3327/000119312506132721/dex99.htm}

^{[9] https://www.sec.gov/Archives/edgar/data/62741/000119312507074484/dex991.htm}