Duane Reade and Its Road to Health (Published 2010) (2024)

Good thing Duane Reade is in the pharmacy business.

Over the years, the chain that seemingly dots every corner of Manhattan has been in dire need of some strong medicine for what some thought was one of the sickest patients in the private equity world.

Taken private by a small firm, Oak Hill Capital Partners, in 2004 for $750 million, the deal was described only two years later by BusinessWeek as “an L.B.O. on the critical list,” adding that a “three-year debt binge turned the drug chain from gem to junk.”

Like a homeowner overstretched with a big mortgage on an underwater property, some bondholders whispered back then that the company might have to file for Chapter 11.

Now, we have the latest chapter in the twists-and-turns story of a New York institution.

Last week, Duane Reade agreed to be sold to its giant rival Walgreen for a whopping $1.1 billion, including debt — an earthshaking deal for Manhattan that even topped the local evening newscasts.

After all, there are 253 of the stores in the city, and love ’em or hate ’em, everyone’s got an opinion (type Duane Reade and Facebook into Google, and the first two results are for an “I Hate Duane Reade” Facebook page, higher than Duane Reade’s own corporate Facebook page).

But Duane Reade is as much a story about selling milk and toothpaste at 2 a.m. as it is about Wall Street, financial engineering and shifts in the private equity industry.

Duane Reade was born in 1960 when a couple of brothers, the Cohens, started Duane Reade on Broadway between — you guessed it — Duane and Reade streets.

In 1992, after building stores all around the city, the brothers looked to cash out, as many family-run businesses do.

The brothers found a willing buyer in Bain Capital of Boston, which leveraged the business and took advantage of the favorable economic winds in 1997 and sold a majority stake to Donaldson, Lufkin & Jenrette (the investment bank that was later merged with Credit Suisse). Andrew Nathanson, a banker at D.L.J., then turned around and took Duane Reade public in 1998, just as the dot-com boom was in full swing and lifting everything under the sun, even mundane drugstores.

For several years, Duane Reade continued to bumble along, expanding its footprint around New York City with its convenient yet famously cluttered stores.

By 2004, the economy was just beginning to recover from the bubble’s bursting and Mr. Nathanson had left the sinking ship of D.L.J. once it was sold to Credit Suisse. Mr. Nathanson later found himself at Oak Hill, casting for acquisition targets.

With debt at historically cheap prices, he went about rebuying Duane Reade, teaming up with the company’s chief executive, Anthony Cuti, taking the company private and loading it up with $500 million of debt.

With private equity firms buying companies and flipping them within a year or two, Duane Reade looked like a sensible financial-engineering play.

All the trend lines showed that as New Yorkers got older, Duane Reade would be in even greater demand. All they had to do was to keep the proverbial shopping cart from hitting the basket of ChapStick at the checkout line.

And they blew it. By 2006, the business was hemorrhaging money and a series of scathing articles called Duane Reade a “zombie: dead, but walking among the living,” as BusinessWeek put it. It didn’t help that Mr. Cuti may have inflated the company’s income; he has since been indicted on charges of securities fraud. (Mr. Nathanson retired from Oak Hill that same year and died in a surfing accident last summer.)

But here’s where the story takes a surprising, and positive, turn. While private equity firms often talk a good game claiming they are operators, and not financial engineers, Oak Hill proved that it actually could run a company.

It installed a new management team led by John A. Lederer, the chief executive, that re-imagined the entire experience.

Been to a Duane Reade in the last couple of months? Some of the refurbished stores are actually a delight to shop in; the sales lines are shorter and the stores refreshed. (Thank you in advance for all the e-mail messages from everyone who disagrees.) Indeed, it was these improvements that caught the eye of Walgreen’s management, many of whom had written off Duane Reade altogether.

Usually rivals acquire each other to gain market share, but this deal appears to be as much about getting the knowledge that Duane Reade’s management has developed to help recreate that experience for Walgreen in other urban areas.

That’s not to say that Walgreen wasn’t looking to gain market share and squeeze savings — it was — but it was also about taking advantage of its operational excellence.

Walgreen first approached Duane Reade over the summer, but the talks went nowhere because Oak Hill was in the middle of refinancing its debt. But by December, Project Dakota, as it was known around Walgreen, was in full swing with the deal finally announced last week.

Despite the $1.1 billion price tag for Duane Reade, the deal didn’t turn out to be a home run for Oak Hill, which is another theme of the changing landscape of private equity.

Oak Hill made 1.5 times its money over six years, or about 11 percent on an annualized basis. On a relative basis to the market, that’s not a bad outcome. And considering what people were saying about Duane Reade four years ago, it is a great return.

But compared with the returns of yore — firms making two, three, four times their money — this deal may actually represent the new normal. Nothing fancy, just the basics. Kind of like Duane Reade itself.