GETTING the Merger Formula RIGHT.

Like most of today's largest banks, FleetBoston Financial Corp. is the product of a series of mergers dating back to the 1980s. Unlike many of its peers, however, Boston-based Fleet has proven time and again that it knows how to make mergers work.

With a merger team headed by long-time Fleet veterans Eugene McQuade and H. Jay Sarles -- chief financial officer and chief administrative officer, respectively Fleet has earned a reputation as one of banking's most skilled acquirers. It is careful not to overpay, then uses its strong integration and financial engineering skills to extract maximum value from its acquisitions. Just as importantly, Fleet has avoided the major blow-ups that have plagued other high-profile bank purchasers in recent years.

Fleet has used its deal-making savvy and integration skills to string together enough successful deals to become the eighth largest commercial bank in the U.S., with $181 billion in assets. The U.S. banking industry has undergone tremendous consolidation over the past 15 years, and under the leadership of chairman and chief executive officer Terry Murray, Fleet has expanded well beyond its heritage as a small Rhode Island bank to become a diversified financial services conglomerate. It now has a large commercial bank in the Northeast, a Latin American operation, a brokerage firm and a discount broker, a credit card company and a commercial finance unit.

While Murray calls the shots, it's up to McQuade and Sarles to execute the bank's expansion strategy. The two executives, both vice chairmen who report directly to Murray, have developed a close working relationship, and their respective departments have handled enough acquisitions over the years to qualify for expert status.

"Fleet has a very well-regarded acquisition team," says investment banker Richard Barrett, head of the financial institutions group at Credit Suisse First Boston. "They look for value. They're a little contrarian. They like to be in when other people are out." Adds CIBC World Markets bank analyst Thomas McCandless, "They've done more creative deals over time than anyone else."

The roots of Fleet's M&A strategy lie in a brutal recession that wracked New England in the early 1990s, brought about largely by the collapse of the region's commercial real estate market. A significant number of New England banks failed, and even many of the survivors struggled for several years afterward. Fleet was one of the survivors, in large part, because it had diversified out of the region by merging with Albany, N.Y.-based Norstar Corp. in 1988. While most of the country was affected by the real estate crisis, upstate New York was hurt less than New England, and the old Norstar franchise helped keep Fleet afloat.

The region's economic crisis led directly to three strategic imperatives that have driven Fleet ever since. "One was that size was going to be important to be a survivor and a player," says Sarles. "If we wanted to be an independent company based in New England, we were going to have to grow. Two, we wanted to have significant diversity in the types of businesses we had and their geography. And three, we wanted to have a very strong banking franchise, but we needed to marry that with faster-growing [nonbank] financial services businesses."

What followed was a series of acquisitions that dramatically transformed the bank, starting with Bank of New England in 1992, BNE ended up a casualty of the real estate market and was taken over by the Federal Deposit Insurance Corp. when it failed. Teaming up with the buy-out firm Kohlberg, Kravis & Roberts, Fleet outbid Bank of Boston Corp. and Bank of America Corp. to win BNE from the federal agency in an auction.

With that deal, Fleet's heftier balance sheet and stronger earnings helped it ride out the region's economic turmoil. The acquisition of Shawmut three years later helped solidify Fleet's position in New England. Fleet, which had been based in Providence, R.I., moved into Shawmut's Boston headquarters. Closely following Shawmut was the acquisition of NatWest USA, which provided Fleet with even more geographical diversification.

Next up were three nonbank acquisitions, beginning with Fleet's purchase of Advanta Corp.'s credit card portfolio in 1997. This was soon followed by a deal for Sanwa Business Credit, a commercial finance company, and Quick & Reilly, a discount securities broker. Fleet's largest transaction -- and the one that promises to have the biggest impact on the company -- was the 1999 takeover of archrival BankBoston Corp. That deal gave Fleet unrivaled dominance in the New England banking market.

Just as importantly, perhaps, BankBoston contributed two fast-growing nonbank businesses. One was BankBoston's highly regarded Latin American unit, which does business in Brazil and Argentina as a local bank. The other was BankBoston's Robertson Stephens investment banking subsidiary, which is considered a powerhouse in the technology sector and gave Fleet's commercial banking operation the securities underwriting capability it lacked.

Lastly, Fleet announced the acquisition of Princeton, N.J.-based Summit Bancorp last September, a deal that will greatly strengthen its position in New Jersey and extend its reach into eastern Pennsylvania. "[Fleet is] weak in New Jersey," says CIBC's McCandless. "It's not [currently] strong enough to be a primary player there. The deal also provides a platform for further expansion west."

Like a bodybuilder, Fleet's prowess as an acquirer is, in part, the result of repetitions. Few U.S. banks over the previous decade have done more deals, with the possible exceptions of two Charlotte, N.C.-based companies, BankAmerica Corp. and First Union Corp. But unlike those organizations, which have experienced considerable indigestion in assimilating some of their deals, Fleet's have largely gone off without a hitch.

There are several factors behind the bank's success, beginning with the fact that it resolutely refuses to overpay. Says McCandless, "They fight over every nickel and dime. They've got a reputation as a difficult negotiator." Part of Fleet's expertise at pricing deals comes from knowing how much it can afford to pay. McQuade uses two sophisticated computer models to evaluate potential acquisitions in terms of their internal rate of return and also whether they would be accretive to earnings per share.

"We've got a number of Ph.Ds who run this stuff for us," says McQuade. "Jay [Sarles] and I look hard at the results and decide whether the finances make any sense to us. I think we have an ability -- better than almost anyone I know -- to look at a transaction from the outside and understand how that would translate to us even before we do due diligence. So when we get to due diligence, we're really confirming rather than learning whether our model works or not."

McQuade and Sarles also have disciplined themselves to look at every assumption very closely. "We try to be absolutely hard-nosed about how much growth we're going to get, whether we can get the cost saves and how much lost revenue there is going to be," McQuade says.

Fleet also has developed the discipline to walk away from an attractive franchise when the price tag is simply too high. Cases in point are Summit and the former CoreStates Financial Corp., which was headquartered in Philadelphia. Fleet looked at both companies about five years ago and decided the pricing was too steep. CoreStates was eventually acquired by First Union for an extremely high premium, and the deal turned into a disaster for the North Carolina bank in part because it had to cut costs aggressively to earn back the premium -- triggering terrible customer service problems.

"Summit probably would have sold at four times book value in those days," reflects McQuade. "But the prices didn't work for us, and we were willing to take the risk that both companies would be sold simply because we didn't think we could earn enough for our shareholders on them. Luckily, Summit didn't get sold, and we probably got it for 60 percent of what we would have had to pay a couple of years ago."

Fleet also has proven to be very opportunistic, although an equally apt description would be persistent. The NatWest USA deal exemplified both characteristics. Murray wasn't all that eager to bid for it, but McQuade and Sarles persisted because they saw themselves gaining the inside track as other bidders pulled back, and believed they could steal a valuable franchise at an attractive price.

An even better example would be Fleet's acquisition of BankBoston, which it had pursued for several years, beginning in 1995 and again in 1998. Each time, Murray failed to put together a deal. His persistence finally paid off in 1999 when BankBoston CEO Chad Gifford began to worry that his company's reliance on its fast-growing but volatile Latin American and investment banking businesses was dragging down its stock, and he saw a merger with Fleet as a solution. The resulting transaction has given the combined company a nearly unassailable position in the New England market, along with the revenue diversification that Murray and his team have long sought.

Skilled Intergrator

As important as it is to negotiate a smart deal, the ultimate success of many acquisitions is determined by what happens after the contract has been signed and the champagne magnums drained. Fleet may be one of the best integrators in banking because it has developed a proven methodology for stitching two organizations together with minimal disruption. Integration is key because in most bank mergers, the acquirer is counting on getting significant expense reductions that will translate into higher earnings. If it can lower the target bank's overhead without giving up much revenue, the result is a big increase in the acquirer's earnings per share. And the quicker the integration is completed, the sooner that higher EPS will kick in.

Under Sarles's direction, Fleet's integration team quickly puts together a blueprint that maps out the entire project and assigns a timeline. "It's basically a very detailed planning process that goes into each business and says, 'Okay, what products are we going to have, how are they going to be delivered, which branches are we going to keep, how are we going to make the hand-off in terms of customers?"' Sarles explains. "It's an incredibly detailed plan that gets developed with action steps."

Fleet combined its operations with BankBoston's in just six months, and is closing in on its stated goal of eliminating $600 million in annual costs without a corresponding loss in revenue. In the Summit deal, Fleet has committed to taking out $475 million in expenses and wants to complete the integration by June 30, 2001.

As he did with NatWest, McQuade also sees opportunities to reengineer the acquired company's balance sheet. Summit has assets and liabilities of approximately $40 billion, which McQuade wants to pare to approximately $25 billion this year. One payoff of such a restructuring is a higher net interest margin as expensive funding sources or under-performing assets are sloughed off.

Shrinking an acquired company's balance sheet also reduces the amount of equity capital that must be carried to support it, which improves returns. McQuade says financial reengineering creates as much or more value as the integration itself. "Some deals have gotten into trouble because people didn't remedy the balance sheet early enough and wound up with interest rate mismatches and other things that left them at risk over time," he says.

About the only disappointment Fleet has experienced of late has been the reluctance of institutional investors to climb aboard the company's bandwagon. Through early

December, the company's stock was trading at a lackluster 12.5 times earnings, which is roughly in line with its peers but well below what McQuade and Sarles believe the company is worth. Part of the problem was the decision by many investors to wait and see whether Fleet could successfully integrate the BankBoston deal. Now that that project is drawing to a successful conclusion, investors are fretting over the deterioration in loan quality that has dogged most commercial banks in recent quarters, Fleet included.

The market's reaction aside, McQuade believes that Fleet has created enormous shareholder value in recent years. He points to two deals in particular as evidence. "We bought Quick & Reilly for $1.5 billion, and now it could be worth between $7 billion and $10 billion," he argues. "That clearly is not reflected in our [stock], but there's tremendous value in that business. Advanta -- the same thing. We bought that business for $500 million, and we could probably sell that today for $3 billion."

McQuade holds out high hopes for the BankBoston merger as well. "We have created some value through the cost saves, but more importantly, as we get more and more into this, we're more excited about the synergies and revenue growth opportunities between these two companies over the next two to five years," he says. "I think there will be tremendous value that comes out of that."

Over the next five to 10 years, Fleet wants to become one of the top 10 or 15 diversified financial services companies in the U.S. It will need to pull off several more successful mergers to get there, a challenge it seems well-equipped to meet. "I think we've got a shot at it," says McQuade. Indeed, when you look at how far the company has come in just 10 years, who would want to bet against it?

Jack Milligan is a freelance banking and business writer in Charlottesville, Va.

Garden Slate Deal Comes Up Roses

If one deal showcased Fleet's well-honed acquisition skills, it was the 1996 purchase of National Westminster's branch banking operation in New York and New Jersey. The large British bank had decided to sell off its consumer banking business in the U.S., and while the highly acquisitive Fleet normally would have been interested, this time it was reluctant to bid.

Just months before, Boston-based Fleet had acquired Shawmut National Corp. in its home New England market and was still combining the two companies' operations. Buying the NatWest franchise would require Fleet to handle two large mergers simultaneously, putting a huge strain on its management resources. But Fleet soon realized that it had the inside track as other regional competitors, a few of which were preoccupied with recent acquisitions of their own, dropped out of contention.

After an intensive two-week negotiating stint, during which McQuade and Sarles camped out at NatWest USA's New Jersey headquarters, Fleet won with a low-ball bid that used an innovative structure to skirt a thorny goodwill problem that otherwise would have been a deal-breaker.

On the advice of its investment banker, Richard Barrett (then at UBS Securities), Fleet structured the transaction as an earn-out, meaning that payments to NatWest would be stretched out over a four-year period. Earn-outs are common in other industries, but rare in banking. This arrangement allowed Fleet to stretch out the recognition of goodwill over a four-year period instead of recognizing it all up front. The structure also saved Fleet from having to raise $1 billion in capital.

In another significant move, McQuade later reengineered NatWest's $33 billion balance sheet by shedding nearly $15 billion in high-cost deposits and low-yielding assets, which drastically reduced the amount of new equity capital Fleet had to raise to support the deal. And the integration of the NatWest branches went smoothly despite the added strain of integrating Shawmut as well.

Five years later, the deal still brings a smile to Sarles's face. It strengthened Fleet's banking presence in the Greater New York area and expanded its franchise into New Jersey, while boosting the bank's profitability. "We kept the core franchise of that $18 billion, and after a couple of years it was earning $325 million to $350 million [annually] and getting top returns, almost 2 percent on assets," he says. "It was a solid acquisition because we didn't pay a big premium -- and then Gene's [McQuade's] engineering turned it into a great transaction."