In downtown Roanoke, Va., a few weeks ago, a group of about 40 men and women checked into the Patrick Henry Hotel. Clad casually, many in shorts and T-shirts, the guests registered as members of the "Blue Ridge Motor Club" and said they were attending a travel convention.
But their real mission was to buy Dominion Bankshares Corp., the city's biggest banking company.
An Elite Team
Unbeknownst to the hotel staff, the visitors were part of First Union Corp.'s elite due-diligence team.
For about five days, the group was closeted in hotel rooms and worked around the clock examining loan files sent over in vans from Dominion's headquarters a few blocks away.
Another 100 or so First Union employees at four other sites around Virginia were analyzing the rest of Dominion's operations.
Within a week, the group's work was complete: Charlotte, N.C.-based First Union announced it would acquire Dominion for $830 million in stock.
Although all banks conduct extensive examinations before making acquisitions, few have as much experience as First Union. During the past seven years, the company has completed about 30 acquisitions, allowing it to develop a highly respected methodology for reviewing the books of potential targets.
"We can't remember working with anyone who does a better job of due diligence and ensuring the results are incorporated into the strategy, pricing, and documentation of the deal," said Paul Burke, a vice president at Bankers Trust Co. in New York. Bankers Trust advised First Union on its bid for Dominion and other acquisitions.
High Price Tag
When the Dominion deal was announced on Sept. 21, Wall Street gasped at the price: 1.6 times book value seemed rather high for a bank with serious loan problems. Dominion's nonperforming assets equaled 6.4% of loans and foreclosed property, and many analysts suspected the company had not yet identified all its problems.
But first Union, because of its due-diligence efforts, was confident that Dominion's problem assets had peaked.
"That's what we're banking on in this transaction - not finding any surprises," said vice chairman and president John R. Georgius, who oversees the company's due-diligence efforts. He proudly referred to First Union's due-diligence expertise as "a wonderful secret weapon."
Mr. Georgius's optimism and pride are not unfounded. First Union last year bested two other bidders to win the failed Southeast Bank in Miami. Cost savings from that acquisition have exceeded original projections, and the deal is widely regarded as a major triumph.
First Union has been making acquisitions since the 1960s. But it didn't develop its current cover-all-bases due-diligence methodology until the spring of 1991, when federal regulators invited it to bid on failing Southeast Bank.
The Federal Deposit Insurance Corp. gave First Union and other bidders the unusual luxury of going through every loan in the portfolio before making an offer.
Full Advantage Taken
Acquirees have traditionally been reluctant to allow competitors that much access to their books. First Union used this opportunity to much fuller advantage than three other banks that looked at Southeast.
First Union sent an undercover team to Miami to begin the due-diligence work. Traveling under the name "AAA Motor Club," the First Union employees set up shop in a Sheraton hotel on the outskirts of the city.
They chose the AAA name because the travel company works closely with First Union's own travel services in Charlotte.
While Mr. Georgius retained overall supervision in Charlotte, a key player on the scene was Patrick J. Mulcrone, a 43-year-old senior vice president in the finance division.
Mr. Mulcrone was later awarded First Union's highest internal commendation, the "10th Legion Award," for his work on Southeast's due diligence. The 10th Legion was an elite unit in the ancient Roman army.
At the awards ceremony, First Union chairman Edward E. Crutchfield Jr. noted pointedly that due diligence "can make or break First Union's future."
Mr. Mulcrone and his team developed a series of questionnaires and forms to collect information from Southeast. They also designed a system for processing and analyzing the materials.
Over time, the First Union work force expanded from a dozen to a couple of hundred, which eventually took over several floors of the hotel.
Secret Leaks Out
So many people on the ground were difficult to conceal, no matter how energetically First Union worked to keep the secret. Word leaked out in July that First Union had hundreds of people in Miami going through Southeast's books.
Detection is, in fact, the major disadvantage to First Union's due-diligence approach. Other efforts, including Dominion, were prematurely uncovered.
"It's worth the risk to us," Mr. Georgius said. "We do think with Southeast we knew about as much as you could know about that company."
First Union subsequently employed its revamped due-diligence system on several thrift acquisitions in Florida, Georgia and South Carolina. Earlier this year, it also looked at MNC Financial Inc., Baltimore, but decided not to bid. MNC later optioned itself off to NationsBank.
Investigations in Progress
Mr. Georgius estimated First Union has conducted 26 due-diligence efforts since Southeast, although only 10 resulted in actual deals. The company currently has 17 other projects in various stages of analysis.
Mr. Georgius declined to discuss these other investigations, except for MNC, which First Union publicly acknowledged.
It is known, however, that First Union looked at Houston's First City Bancorporation of Texas, Tampa-based First Florida Banks Inc., and two institutions in Atlanta: First American Bank of Georgia and Georgia Federal Bank.
Smaller Local Groups
For some of the smaller transactions, First Union put together a due-diligence team composed mainly of employees from that particular state. For larger efforts like MNC and Dominion, Mr. Mulcrone headed a companywide team of several hundred strong.
The first step, once First Union has identified a target, is to analyze all the published information available. If First Union is still interested, it sets up a command center in Charlotte and forms the due-diligence teams.
In the case of Dominion, the command center was established on an empty floor at First Union's headquarters tower.
Amid extraordinarily tight security, temporary plasterboard walls were brought in to subdivide the space into offices. Computers were set up on makeshift furniture. The carpets were stained and dirty.
"It's a scruffy area because it's scruffy work. It's roll up your sleeves, dig into it, and get on with it," Mr. Georgius said.
The teams in the field transmit their information to the command center, where it's analyzed and assembled into financial models. When merger talks become serious, First Union begins collecting information directly from every one of the potential acquiree's departments and operations.
"We take all their low-level data and restructure it to look like our bank, meeting our standards and parameters," Mr. Mulcrone said. "We look at factors like revenue projections, expense estimates, head count, and any unusual things that might require us to take special actions."
Mr. Georgius holds the team's feet to the fire by requiring them to be 85% certain on their financial projections. If the transaction goes through, those projections become actual budgets.
As a deal moves into the final stages, the due diligence accelerates to its most intense phase, the loan review. In case of Dominion, this began on Sept. 14, when the "Blue Ridge Motor Club" checked into the Patrick Henry Hotel, about a month after First Union began its preliminary analyses.
Boxes of Loan Files
For the next several days, Dominion shipped boxes of loan files to the hotel. First Union declines to comment, but sources say Dominion also provided access to reviews conducted by the Office of the Comptroller of the Currency.
The First Union team examined every Dominion loan over $250,000, which accounted for nearly 90% of the dollar value of the portfolio.
The teams supervised by Mr. Georgius scrutinized every department and operation within Dominion to compile a five-year pro forma financial projection on the entire company. Even Dominion's employee cafeterias were taken into account.
Ed Patton, executive vice president of risk management at Dominion, said First Union's loan due diligence essentially confirmed Dominion's internal analyses. But he complimented First Union for its thorough approach.
"They turn over all the stones and surface issues very quickly," Mr. Patton said.
Telltale Signs Removed
To protect their identity, the guests at the Patrick Henry avoided using First Union stationery or credit cards.
Their expenses were direct billed to a Greensboro, N.C., office of the AAA Motor Club. They even removed the First Union tags from their luggage.
But the local media eventually discovered their identity. First Union believes their cover was blown when a cabdriver overheard some of its executives talking shop during a ride from the airport.
The news sent Dominion's stock shooting up on Sept. 16, forcing First Union to accelerate its timetable. The negotiations were concluded over the weekend.
On Sunday evening, Sept. 20, the Dominion board approved the deal. The next day, as the news became public, a handwritten sign appeared on the door of First Union's command center in Charlotte: "We did it!"
Crocodiles, Crabs, and Ziplocks: The Fine Art of Keeping a Secret
Conducting due diligence on a potential acquisition is serious business. But First Union Corp. likes to have a little fun, too, at least to the extent of playing around with code names. Consider:
The analysis performed on Southeast Banking Corp., Miami, was "Operation Crocodile," apparently in honor of the Florida swamp creature.
"Alligator" -- the U.S. representative of the crocodile family -- would have been technically more accurate, but First Union's expertise is banking, not zoology. The aborted run at MNC Financial Inc., Baltimore, became "Operation Crab," a tribute to the crabs harvested off the Maryland coast.
A Three-Name Takeover
Among the small circle of executives in the know, the MNC effort informally went by the more endearing "Operation Crabcake."
By the time First Union got around to looking at Dominion Bankshares Corp., Roanoke, Va., it was starting to shy away from names too closely associated with the target bank's locale.
The pursuit of Dominion actually went through three names. The first two were dropped after they became too widely known inside the company.
Vice chairman and president John R. Georgius family settled on "Operation Ziplock" because it had nothing to do with Virginia and served to remind First Union employees to keep quiet.
It didn't work. First Union's secret leaked out anyway.