A Deal For All Seasons

AIR ATLANTA HAS BEEN CREATIVE IN FINDING SOURCES OF CAPITAL -- AND MOST CREATIVE OF ALL IS ITS USE OF ZERO COUPON BONDS.

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The zero coupon is to bonds as the Mexican hairless is to dogs. It looks like the traditional design, but one fixture common to the species is disturbingly missing. Why the dog evolved as bald as Telly Savalas (or vice versa) is anyone's guess, but the band's absence from periodic interest payments, or coupons (a term derived from the old days when you literally snipped payable drafts from the certificate itself), is all too explainable: this era's high cost of money. A zero, as the curious debt instrument came to be called in its heyday only a few years back, is designed so that the borrower does not have to service the debt through periodic cash payouts. Instead, the original loan is discounted from par (in bond biz, "par" equals $100) such that when the borrower pays it back at par on the due date, it yields the equivalent of the missing interest. In addition, kickers can be attached to the zero to make it even more enticing to otherwise timid lenders. These can include warrants that provide for buying more stock within a given time period, options for buying yet more -- and cheaper -- stock, stock in another corporation, interest-bearing preferred stock, and dinner at The Four Seasons.

A freewheeling zero is the kind of ingenious win/win financial showpiece that only capitalists could dream up. The borrower gets money interest-free, while for the lender the locked-up nature of the zero cements the rate of compound interest for the duration of the bond (which can be 25 years or more). When the bond is redeemed, some of the income might be reported as a long-term capital gain. With all that going for them, zero-based packages became hot brokerage-house retail items in the tight-money Carter regime, when lending rates were approaching the batting average of the Atlanta Braves. Even large and responsible public corporations seized the chance to unshackle themselves from expensive debt service, and to cast their lot with possibly better borrowing terms next century. So did marginal operations that could barely meet their Coffee-mate budgets.

The no-tickee no-money concept is neither new nor necessarily suspect. Certain federal obligations have been auctioned at original-issue discount (OID, to your accountant) for decades; you lend the federal government $900, say, and in a year the U.S. Treasury (if it's still around) will give you back $1,000, paying 11% interest. Now that the cost of capital somehow has Laffer-curved back into single digits, however, zero coupons have shed much of their service-free cachet. And a 1982 Tax Equity and Fiscal Responsibility Act (TEFRA) provision that holders of zeros and other OIDs must pay taxes as if they had collected the interest payments has but the kibosh on the retail market as well.

That might have been sufficient to maim an ordinary capital scheme like, say, the research and development partnership. Not so the flexible zero. An inventive application of OID financing recently emerged as an early-round font of working capital for a start-up enterprise. The business -- Air Atlanta Inc. -- was incorporated in May 1981 by Georgia native Michael R. Hollis, a then-27-year-old lawyer and investment banker. In an industry noted for its swift consumption of cash as well as gas, one of deregulation's newest airlines has been issuing zeros for the lion's share of its money. Although more than $5 million was raised in common stock, as of year-end 1985, interest-free debt instruments -- in this case, convertible debentures -- accounted for roughly $19 million of Air Atlanta's total funding of $54 million, exceeded as a single source only by a capital lease on its fleet of jets.

The company's reliance on a zero coupon convertible debenture for its very sustenance is thought to be unique not only in the annals of the airline industry, but among start-ups anywhere. Nor do the contributions come from kinfolk taking fliers. Air Atlanta's lenders are such demanding investors as Aetna Life Insurance, Equitable Life Assurance Society of the United States, and General Electric Credit, which together have loaned $13.6 million via zero coupons to the still-profitless carrier.

How were traditionally conservative asset managers persuaded to take on unsecured debt, payable no sooner than five years from issue, by a fledgling carrier that had only four routes and five planes; had been forced to cancel a public offering due to lack of Wall Street sponsorship; owned few assets (and those pledged as security under other instruments); was knocking heads with Eastern and Delta out of Atlanta by promoting deluxe service (including gourmet meals, free drinks, wide seats, and shrunken margins); had yet to enlist a big-name airline to feed in passengers; and was trying to take off vertically in a sector where no airline has made a profit in its first year and in which other haulers were dropping like -- to be discreet -- flies?

Keep sweetening the deal, answers Daniel H. Kolber, a corporate attorney who worked with founder Hollis on designing the zero vehicles. Saddled with the title of vice-president of communications and industry affairs for his efforts, the diminutive executive insists that rounding up wherewithal is mostly a matter of being able to answer skittish investors' objections.

"It's the same as closing any sale," avers Kolber, who helped coax the deal around a New York statute prohibiting insurance companies from owning voting shares by an on-the-spot redefinition of the proffered stock as Class B nonvoting, amendable to Class A voting at the lender's, if not the state legislature's, discretion.

Like apricot jam in a Sacher torte, the tastiest layer of Air Atlanta's debentures is their potential transmogrification into a generous chunk of ownership. But why not peddle common stock in the first place? For one thing, it would have been though to convince venture capitalists to back a couple of buddies only a few years out of the University of Virginia School of Law, one black, the other white.

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