Vornado in the Land of Toys - TheStreet

While shares of

Toys R Us

(TOY)

took the spotlight Thursday, adding 5% on news the chain had been sold, investors were also applauding one of the winning bidders.

Vornado Realty Trust

(VNO) - Get Report

closed up $1.49, or 2.1%, to $72.49. The company is an equal partner in the winning bid for Toys R Us, valued at $6.6 billion, alongside two private investment groups:

Kohlberg Kravis Roberts

and

Bain Capital

.

Wall Street views Vornado's presence in the triumvirate as evidence that the buyout is partly a real estate play. Run by investment guru Steve Roth, Vornado has a history of extracting value out of troubled retail properties. With the real estate market on fire and speculation about hidden riches in old-school retail sites running rampant, investors are betting the deal could be a big win for Vornado.

Goldman Sachs analyst Carey Callaghan thinks Toys R Us offers "a very interesting real estate opportunity," but in a research note published after the deal closed, he said the toy retailer's price tag may be too rich for Vornado to reap any big rewards.

"

Based on our liquidation scenario for the domestic toy business over a 10-year time frame, we believe this could deliver acceptable but not attractive returns on the real estate portfolio," Callaghan said.

Acceptable returns may not be enough for Vornado. Based on his analysis, Carey is cautious on the stock, advising investors to "use share price strength to reduce exposure."

Investors threw caution to the wind last November, when Vornado revealed a leveraged ownership stake of 4.3% of

Sears'

(S) - Get Report

common stock, sending Sears shares up 23% in one day. Two weeks later, ESL Investments hedge fund manager Ed Lampert announced that

Kmart

(KMRT)

had agreed to buy Sears in a blockbuster deal worth $11 billion that would create the third-largest discount retail chain, behind

Wal-Mart

(WMT) - Get Report

and

Target

(TGT) - Get Report

.

Vornado made a fortune on the deal, as Sears shares have continued to skyrocket. But some think Lampert's abrupt move was made to defend his stash of undervalued real estate assets. He had already owned a stake in Sears, and Kmart, which he rescued from bankruptcy in 2003, had earned millions selling property. Now, with the deal set to be finalized later this month, Kmart and Sears each boast rich valuations based largely on speculation about hidden asset values.

Meanwhile, most analysts agree that Toys R Us lays claim to real estate that is probably more valuable than Sears'. While Sears owns a number of mall-anchor sites that are increasingly falling out of favor as consumers continue to migrate to off-mall shopping locations, Toys R Us owns 685 stores, most of which are in well-populated, off-mall locations with large parking lots that are highly sought-after by many big-box retailers.

By way of valuation, Callaghan said Thursday's deal gives Toys R Us an enterprise value of $6.8 billion, adding $200 million in net debt to the price tag. He valued its still-healthy Babies R Us business at $2.5 billion, and its remaining stake in a Japan subsidiary at $200 million. Deducting these units leaves the toy business priced at $4.1 billion, a $600 million premium to Goldman's estimated value of $3 billion to $3.5 billion.

That estimate was based on a liquidation scenario for the underperforming domestic business, worth $1.85 billion, and its healthier international operations, worth $1.74 billion.

"Returns on the

domestic business real estate under our real estate liquidation scenario could be in the mid to high teens, depending on leverage attached to the assets," said Callaghan, who does not own shares of Vornado, but whose firm does have an investment banking relationship with the company. "With a valuation difference of $600 million, we believe these returns would be less."

To be sure, Vornado's Steve Roth and Michael Fascitelli have an impressive track record when it comes to liquidating struggling retailers and extracting value from their real estate. For instance, they brought

Alexander's

, once a New York-based department store chain, out of bankruptcy in September 1993 as a real estate investment trust focusing on its former locations. More than 10 years later, the time could be ripe for another such venture.

Also, there is no telling for sure what the buyers have in store for Toys R Us. Bain Capital, as the largest stakeholder in

KB Toys

, could have a toy merger in mind, and KKR, the firm famous for winning the takeover battle for RJR Nabisco in the late 1980s, expressed a desire to keep the retailer alive.

"We look forward to building on the many strengths of the company to make the stores a better place to shop and work," KKR director Michael M. Calbert said in a statement.

Goldman's Callaghan acknowledged that even Vornado's intentions with Toys R Us are uncertain.

"Most importantly, there is no indication that a full liquidation of the U.S business is contemplated," he said. "In fact, discussion with

Vornado's management suggest that the expected returns from operating the domestic business are materially higher than for a liquidation scenario."