(Corrects fourth paragraph to say that the deal includes the assumption of $457 million in addition to the $618 million in cash paid for the equity)

NEW YORK - Walgreen Co will buy Duane Reade for $618 million in cash, catapulting the largest U.S. drugstore operator into the top spot in the New York City area.

Duane Reade is owned by private equity firm Oak Hill Capital Partners LP and operates 257 drugstores in the New York metropolitan area. Its sales totaled $1.8 billion last year and it has the highest sales per square foot in the U.S. industry, according to Walgreen.

We like their footprint, how it matches up with us, Walgreen Chief Executive Greg Wasson said of Duane Reade in a Reuters interview. (It) gives us a leading presence in Manhattan as well as supplements what we have in the boroughs in New York.

The deal also includes the assumption of $457 million in debt. Oak Hill Capital Partners took Duane Reade private in July 2004 in a transaction valued at about $700 million, also including debt.

Duane Reade will continue to operate under its brand name and Walgreen expects to retain the employees at its stores, pharmacies and distribution centers.

Walgreen operates 70 stores in the New York area, including a multi-floor outlet in Times Square across the street from a Duane Reade store.

It expects the Duane Reade acquisition to dampen its earnings in the first 12 months after closing, expected by August 31, and then add to earnings in the years following. It sees potential savings of $120 million to $130 million in the third year after closing.

Duane Reade opened in 1960, named after its first location near New York's City Hall on Broadway, between Duane and Reade streets. The company began to overhaul its stores in the last two years to update its decor and add walk-in health services.

Walgreen said these strategies complemented its own efforts to better tailor its drugstores to local markets.

Peter J. Solomon Co. was financial adviser to Walgreen and Wachtell, Lipton, Rosen & Katz served as legal counsel. Goldman Sachs & Co and Bank of America Merrill Lynch were co-financial advisers to Oak Hill and Duane Reade, with Paul, Weiss, Rifkind, Wharton & Garrison providing legal counsel.

Walgreen shares were down 38 cents at $33.60 in premarket trading.

(Reporting by Phil Wahba and Jonathan Stempel; Editing by Michele Gershberg and Derek Caney)