By  on February 19, 2010

NEW YORK — The Walgreen Co. has itself a beauty of a deal.

After months of speculation, Walgreens announced its $1.1 billion bid, which includes the assumption of debt, for Duane Reade’s 257-store metro-New York operation from affiliates of Oak Hill Capital Partners.

Although Walgreens has made acquisitions before — including buying the Newark-Del.-based Happy Harry’s in 2006 — the chain has traditionally grown through store openings. In an interesting twist, Walgreens once was a dominant name in New York City before deemphasizing the market in the Seventies.

Beyond the instant access to some of the highest producing sales per square drugstores in the country (Duane Reade stores produce in excess of $1,000 per square foot, albeit at lofty rents, versus some drug chains that don’t crack $300 in per foot sales), the acquisition will bolster Walgreens’ beauty profile.

“As a vendor to both companies, we think the possibilities are phenomenal. In the context of urban marketing, no one has accomplished more, faster, in this category than Duane Reade, and the maintenance of senior management assures those great creative ideas and programs will continue to develop and expand, just on a larger stage,” said Mark Crames, chief executive officer of Demeter Fragrance Library, which distributes to both chains. “Both are great trading partners, and they complement each other’s strengths,” he said.

Some industry observers feel Walgreens has fallen behind competitor CVS Pharmacy in the beauty aisles after years of dominating the category. Duane Reade recently made a huge splash with its Look Boutique, which debuted in Herald Square last fall and is now duplicated in three other Manhattan units, with plans for a larger rollout.

Beyond traditional mass market fare, Duane Reade has tapped edgier brands, including Too Faced, Pop Beauty and Global Goddess, while also enhancing its skin care presence with Vichy, Rilastil and La Roche-Posay. The salon hair care section features professional brands, including Bumble & bumble, PureOlogy and Keratase, as well as a display of Moroccan Oil.

For many years, Walgreens was mass market beauty royalty; its stores sold more fragrances than other drugstore chains and its beauty advisers were legendary for their knowledge of the product selection. At a time when other chains abandoned service, Walgreens kept in-store service and a network of supervisors. However, over the last two years, the supervisor roles were reduced at the same time beauty was put under the microscope. Low-producing brands were eliminated; cosmetics stockkeeping units were cut.

At the same time, CVS elevated its beauty presence with the opening of Beauty 360 boutiques, and with a better selection and service in its traditional stores. Recently, in fact, units with the skin care centers at the rear of the department were remerchandised, putting lines like Vichy and Avene front and center. This past Christmas, CVS made its biggest push to date in fragrances, a category that was once the domain of Walgreens in the drugstore battles.

While the two behemoths battled it out. Duane Reade started an overhaul of its stores, which were always known for a broad selection of cosmetics, including hard-to-find brands. But its stores were not always associated with a snazzy ambience. New advertising, graphics and management were put into place. Among those moves was tapping Joe Magnacca, now Duane Reade’s senior vice president, chief merchandising officer, who had experience at Shoppers Drug Mart and its upscale beauty format called Murale. As new stores opened, New Yorkers took notice and when Herald Square opened, it was a store that even took suppliers and competitors by storm.

A visit to the unit, located directly across from Macy’s, on Tuesday revealed the strides made at Duane Reade, including a slick nail bar featuring its own $6 nail color merchandised next to OPI and Essie, an upscale-looking tools department and a wide array of niche and mass beauty brands, including the big guys like Cover Girl and L’Oréal Paris, and up-and-comers like Milani. Duane Reade is often a first to test new items, such as the new lash enhancers. Even before the new design, suppliers always credited Duane Reade with making space to give new brands a try, and the chain has a cadre of legendary beauty alumni including Karen Durham, now an industry consultant, as well as the current cosmetics executive Marcia Gaynor, who had a hand in creating the Look Boutique.

Further uptown, a visit to the flagship Walgreens in Times Square shows the retailer’s merchandising program, the Customer Centric Retail initiative, has deemphasized beauty in this store. While the large L’Oréal department (which was being used to videotape a message from president and chief executive officer Greg Wasson on Tuesday, the day before the deal was announced) is still intact, the main promotional aisle near the beauty entrance has been turned over to Walgreens’ health and beauty brands.

The merger does net Walgreens a great inventory of stores that will boost its presence in the New York market. However, as with all acquisitions, it is not without obstacles.

With Duane Reade, Walgreens buys a patchwork of stores with myriad layouts that one supplier said could be the “remodel from hell.” And, with its strict eye on productivity, some of the brands Duane Reade cultivated and helped grow could come under the editing pencil. “Those niche brands can just put a fork in it,” said one supplier. Another added, “I think the loss of Longs Drugs and Duane Reade as independent is not a great thing, especially for smaller brands. There are now four or five drugstore customers, and if you cannot make it with one of those, it is a small universe. Unless Walgreens maintains and uses that entrepreneurial spirit at Duane Reade, it will be a loss for everyone.” He continued, “My experience is that there is a tendency for big companies to eliminate the specialness that first attracted them to the target. I just hope that does not happen.”

Walgreens also hasn’t been known for successfully digesting chains, dating back to the Eighties when it purchased Medi-Mart and most recently with its buy of Happy Harry’s.

While CVS is applauded for its seamless takeover of Eckerd, industry experts said Walgreens found many distribution and logistics nightmares in assuming Happy Harry’s.

Happy Harry’s has many parallels to Duane Reade. Both chains had stellar reputations in their respective markets. Walgreens said it will maintain the Duane Reade nameplate. It has kept the Happy Harry’s name active with a small notation that it is a Walgreens Pharmacy. Duane Reade management is expected to stay intact, but most Happy Harry’s employees were not added to the team at Walgreens.

For the Duane Reade transaction, Peter J. Solomon Co. acted as financial adviser to Walgreens. Goldman Sachs & Co. acted as lead financial adviser, and Bank of America Merrill Lynch acted as co-financial adviser to Oak Hill Capital Partners and Duane Reade.

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