PE Week Wire: Thurs., July 26, 2007

Some Democratic lawmakers are talking compromise on the carried interest tax kerfuffle. The only problem is that they seem to be compromising with themselves, while the GOP digs in at Fort Status Quo.

To date, the issue has boiled down to this fundamental question: Should carried interest be treated by the IRS as capital gains or as ordinary income?

In response, most people have felt compelled to pick sides. For example, the leading Republican presidential candidates have all expressed support for the current capital gains treatment, while their Democratic rivals are in favor of a change to ordinary income. Over at peHUB, I have written that ordinary income is more applicable, while my colleague Alex Haislip has argued forcefully for the maintenance of present policy. I also expect some divergence when discussing the issue later today at the Private Equity CFO Conference here in Redwood City.

But what if all of us were wrong to pick sides? What if carried interest has significant characteristics of both capital gains and ordinary income – and, conversely, significant character flaws in both regards? What if it is really an amalgam of the two, and our real debate is over percentages rather than over absolute values?

That’s where the aforementioned compromise comes in. I’m told that certain Democratic lawmakers are borrowing from something known as the 60/40 rule, which was originally designed to dissuade futures traders from engaging in tax arbitrage. In short, it says that gains made on securities like futures contracts are treated as a weighted combination of long-term (60%) and short-term (40%) gains – no matter how long the security was actually held.

The idea is to apply the 60/40 rule to carried interest. For example, perhaps 60% of carried interest would remain taxed as capital gains, while the other 40% would be taxed as ordinary income. Or maybe you play with the percentages, and end up with a 55/45 rule. Either way, it would be a recognition that carried interest has inherent elements of both tax treatments.

The net result, of course, would be a tax increase. Smaller than what’s currently proposed in the Levin bill, but still more than what is currently on the books. At 60/40, it would work out to around 27 percent.

Not a bad idea from my point of view, but this is where political reality is likely to trump tax theology. Most Republicans are dead-set against any sort of tax increase on carried interest, because they view it as an opening salvo against the 15% capital gains rate (for everyone). As one private equity lobbyist explained to me: “The question to ask is: ‘Would Grover Norquist would support it?’ It’s not quite that simple, but it’s also not that far off base.”

To be clear, Grover Norquist would oppose the 60/40 compromise.

Another lobbyist said that such a solution could perhaps siphon off a few Republican senators – in addition to existing Finance Committee defectors Chuck Grassley and (maybe) Olympia Snowe – but not nearly enough to overcome an expected presidential veto. For the most part, there is GOP solidarity.

Democratic senators, on the other hand, are all over the map. More specifically, the map is helping to “inform” their position. Chuck Schumer from the Wall Street State, for example, has expressed doubts about the pending legislation – as has John Kerry from VC-heavy Massachusetts. Even Harry Reid of Nevada has said that he is unlikely to bring any carried interest legislation to the floor this year. After all, wouldn’t want to scuttle the next Harrah’s deal…

What all this means is that the Democratic compromise is really an effort to get its own caucus back in line – so that it can use this issue as a marker next November. Very few folks outside the financial and political beltway have even given a passing thought to carried interest, but the basic Democratic sound bite – “Why should billionaires pay 15% taxes on their income” — would be a clear winner. At least at the ballot box. In terms of legislation, it is beginning to look dead on arrival.

Top Three

R.H. Donnelley Corp. (NYSE: RHD) has agreed to acquire for $345 million in cash and deferred purchase consideration. The deal is expected to close later this quarter, at which point CEO Jake Winebaum will be appointed president of R.H. Donnelley’s interactive unit. is a Santa Monica, Calif.-based business search engine, directory and pay-per-click advertising network. It has raised nearly $95 million in VC funding since 1999, from firms like Benchmark Capital, Institutional Venture Partners, McGraw Hill, Cahners Business Information, Financial Times Group and Reed Business Information.

Franklin Resources said that it has raised its position in Dallas-based energy company TXU Corp. (NYSE: TXU) to 5%, and that it will vote against a pending $45 billion buyout by KKR and TPG. Franklin is now the largest outside shareholder in TXU, and believes that the $69.25 per share offer price is too low. A shareholder vote is scheduled for September 7. In other TXY news, the company announced that chairman and CEO John Wilder would retire if the buyout goes through, but would stay on board if it were defeated.

Mark Anson has decided to resign as chief executive of Hermes, and will join Chicago-based fund manager Nuveen Investments as its president. Anson is understood to have resigned after the sudden death of his father, and to help care for his ailing father-in-law. Anson, joined Hermes in January 2006, from CalPERS, where he had been chief investment officer. Rupert Clarke, chief executive of Hermes Real Estate, will serve as interim CEO after Anson leaves at the end of August.

VC Deals

Curse Inc., a San Francisco-based gaming portal focused on MMOGs, has raised $5 million in Series A funding. AGF Private Equity of France led the deal, and was joined by individual angels.

Fusion Antibodies Ltd., a Belfast-based developer of antibody therapies for cancer, has raised £1.2 million in second-round funding. Backers include Crescent Capital, Viridian Growth Fund, Quibis Ltd., University Challenge Fund and Invest Northern Ireland.

DivX Inc. (Nasdaq: DIVX) announced that it is spinning off user-generated video site Stage6 into its own private company. The move is expected to occur later this year, dependent on Stage6’s ability to secure venture capital funding. DivX CEO Jordan Greenhall is stepping down in order to lead the process, while company president Kevin Hall will become acting CEO.

Buyout Deals

Brazos Private Equity has acquired a majority stake in Procura Management Inc., a Norristown, Pa.-based provider of medical cost containment and managed care services. No financial terms were disclosed for the deal, which is being made via a holding company that also will house existing Brazos portfolio company Cypress Care.

The Carlyle Group has completed its €1.48 billion acquisition of Applus, a Barcelona-based provider of inspection, certification, testing and technology services. Sellers included Agbar, Union Fenosa and Caja Madrid. As part of the deal, Carlyle has agreed to sell a 25% stake in Applus to Caixa Catalunya.

Cerberus’ acquisition of automotive group Chrysler looks to be back on track after banks agreed to keep $10 b illion of loans they could not sell to investors.Banks led by JPMorgan Chase failed to find demand for the loans. Cerberus and DaimlerChrysler have reportedly agreed to assume a further $2 billion of loans.

DC Capital has completed its acquisition of Omen Inc., the intelligence services division of Global Analytic IT Services Inc. DC also has acquired Technology and Management Services Inc., and will combine the two companies into a single entity called National Interests Security Company LLC.

Blue Point Capital Partners is in talks to acquire Woodland, Calif.-based WDC Exploration & Wells, according to LBO Wire. No financial terms were disclosed.

Welsh Carson Anderson & Stowe is in talks to acquire Lafayette, La.-based Venture Transport Logistics LLC, according to LBO Wire. No financial terms were disclosed. VTL provides trucking services along the Gulf Coast.

PE-Backed IPOs

ImaRx Therapeutics Inc., a Tucson, Ariz.-based drug company using nanotech therapies for stroke and cancer, raised $15 million via its IPO. The company priced 3 million common shares at $5 per share (down from original $6.50-$7.50 range), which gives it an initial market cap of approximately $50 million. ImaRx will trade on the Nasdaq under ticker symbol IMRX, while Maxim Group served as lead underwriter. Edison Moore Healthcare Ventures held a 4.8% pre-IPO ownership position. ImaRx had filed for a $75 million IPO last year, but later withdrew it due to “unfavorable market conditions.”

Voltaire Ltd., an Israeli developer of interconnect solutions for grid computing, raised $46 million via its IPO. The company priced 5.77 million common shares at $9 per share ($12-$14 range), which gave it an initial market cap of approximately $184 million. It will trade on the Nasdaq under ticker symbol VOLT, while J.P. Morgan and Merrill Lynch served as co-lead underwriters. Voltaire raised around $67 million in VC funding, from firms like Baker Capital, Challenge Fund – Etgar, Concord Ventures, Pitango Venture Capital, QTV Capital, Tamir Fishman Ventures and Vertex Management.

PE Exits

Merck & Co. (NYSE: MRK) has agreed to acquire NovaCardia Inc., a San Diego-based drug company focused on cardiovascular disease. The deal is valued at approximately $350 million in Merck stock, plus the value of NovaCardia’s cash on hand at the time of closing. NovaCardia had been in registration for an $86.25 million IPO, but now is expected to withdraw the filing. It has raised around $88 million in VC funding since its 2001 formation, with its most recent post-money valuation coming in just shy of $100 million. Shareholders include Domain Associates (24.9% stake), Forward Ventures (15.6%), InterWest Partners (10.4%), Skyline Venture Partners (15.3%), Versant Ventures (13.6%) and Montreaux Equity Partners (12.5%).

Firms & Funds

Fortress Investment Group has closed its fifth fund with $5 billion in capital commitments. It also expects to add an additional $1 billion in capital from itself, its affiliates and its employees. The firm declined further comment, citing a pending earnings call.

Third Security of Radford, Va. has closed its fifth fund with $250 million in capital commitments, according to VentureWire. The fund is named New River Management V, and will continue to invest in both private and public companies.

TriWest Capital Partners has closed its third fund with Cdn$250 million in capital commitments. The Calgary-based firm focuses on mid-market Canadian companies with operating earnings of between Cdn$10 million and Cdn$40 million. In conjunction with the fund closing, TriWest has promoted both Chad Danard and Ryan Giles from senior associate to vice president.

Human Resources

Fazel Husain has agreed to join MetalMark Capital as a managing director, with a focus on the healthcare sector. He currently is a managing director with Morgan Stanley, where he has served on the boards of such companies as Allscripts Healthcare, Cambridge Heart, Cross Country, The Medicines Co., SouthernCare Hospice and Suros Surgical.

Dimple Sahni has agreed to join Omidyar Network, effective September 4. She has spent the past two years as a Kauffman Fellow with L Capital Partners.

The Pittsburgh Life Sciences Greenhouse has added three executives-in-residence. They are: Hank Safferstein, former vice president of business development for Omrix Biopharmaceuticals; Samuel Straface, former director of the New Ventures group at Boston Scientific Corp. and David Weaver, founder and president of the Great Lakes Angels.

Morgan Stanley said that Walid Chammah, global head of I-banking, will relocate from New York to London, and be named chief executive of Morgan Stanley International. Gavin McDonald will be named global head of M&A, where he replaces Paul Taubman. Taubman will become co-head of I-banking, alongside Cordell Spencer.