March 17 (Bloomberg) -- Toys ``R'' Us Inc., which was surpassed by Wal-Mart Stores Inc. as the No. 1 U.S. toy retailer in 1998, agreed to be acquired for $6.6 billion by an investment group including Kohlberg Kravis Roberts & Co.

The group, which also includes Bain Capital LLC and Vornado Realty Trust, will pay $26.75 a share, an 8 percent premium over yesterday's closing price of $24.77, Toys ``R'' Us said in a statement today.

Chief Executive John Eyler's moves to remodel stores and improve service wasn't enough to stem declining sales and fend off No. 1 toy retailer Wal-Mart Stores Inc. Investors, who are buying the company partly because of its valuable real estate, are expected to sell some stores to raise cash and try to revive the No. 2 toy retailer, analysts say.

``I'm happy to let them take over the business,'' said Marc Ravitz, who helps manage $650 million, including Toys ``R'' Us shares, at New York-based Grace & White Inc. ``They still will be facing the same fierce competition from Wal-Mart, Target and warehouse clubs.''

Shares of Toys ``R'' Us rose 62 cents to $25.39 in early morning trading before the open of the New York Stock Exchange. Since the company's Aug. 11 announcement that it was considering a sale, shares have climbed 53 percent before today.

The roots of Toys ``R'' Us, which has about 1,500 stores, date back to 1948, when 25-year-old Charles Lazarus opened a baby furniture store and expanded it into a toy supermarket 1957. The company adopted the name Toys ``R'' Us and went public in 1978.

Declining Sales

Elyer said in August he wanted to split off Babies ``R'' Us, its the baby-supplies unit. After bidders made offers for the entire company, the retailer put all its assets up for sale.

Sales and profit at the company's U.S. toy stores had dropped since at least 2001. Sales in the first three quarters of the year in the U.S. toy business dropped 4.4 percent while operating losses almost tripled. Babies ``R'' Us's sales and profit have risen since at least 2001.

Eyler, 57, who joined the toy retailer in January 2000, has cut about 11,000 jobs, or 14 percent of the workforce, to stem the decline in the toy business.

Toys ``R'' Us owns rather than leases most of its property, which made the company more attractive to buyers. It owns more than two-thirds of its buildings or property for its U.S. toy business, according to an annual filing.

KKR

About 75 percent to 80 percent of stores within the retail industry were leased instead of owned, said Robert Futterman, president of New York-based Robert K. Futterman & Associates, a retail real estate sales and leasing firm.

The asking rent for retail properties has risen about 7 percent since August, said Faith Hope Consolo, chairwoman of the retail leasing and sales division at New York-based Prudential Douglas Elliman Real Estate. In the U.S. Northeast, rents have climbed as much as 12 percent.

``This is a real-estate play,'' Consolo said. ``This is a right time to capitalize on that segment of the market.''

New York-based KKR, the world's biggest buyout firm, was founded in 1976. It has financed more than $136 billion in buyouts, according to its Web site. Boston-based Bain Capital was founded in 1984 by Massachusetts Governor Mitt Romney and has more than $17 billion in capital assets under management. It's a principal owner of KB Toys Inc.

Kmart, Sears

Vornado Realty Trust, a real-estate investment company run by Steven Roth, owns office buildings and shopping centers in the U.S. Northeast, including 14.3 million square feet of office space in New York City. In 2004, it bought a 4.3 percent stake in Sears, Roebuck & Co. and has since increased that stake to become among the company's top 25 investors

The buyers would follow billionaire Eddie Lampert, chairman of ESL Investments in Greenwich, Connecticut. He gained control of Troy, Michigan-based Kmart Holding Corp. through bankruptcy and began selling locations to raise cash and boost profit. As of March, Kmart's shares have risen almost sixfold since the company exited bankruptcy in May 2003.

In November, Kmart agreed to buy Sears for $11 billion to create the third-largest U.S. retailer. The Toys ``R'' Us transaction also comes after Federated Department Stores Inc.'s $11 billion cash purchase of May Department Stores Co. in February.

Increasing competition from Bentonville, Arkansas-based Wal- Mart has led to bankruptcies and store closings of toy retailers FAO Inc., owner of Zany Brainy and FAO Schwarz, and KB Toys. The flagship FAO Schwarz store in New York reopened over Thanksgiving weekend, featuring upscale items such as stuffed animals priced at more than $200.

`Brutal Business'

``This is a brutal business,'' said George Whalin, president of Retail Management Consultants in San Marcos, California, who has covered the toy industry for 18 years. ``The real concern is whether you can sell toys on a mass level out of a specialty store against the major competitors.''

In 2003, Toys ``R'' Us earned $1.35 million per 1,000 employees, compared with $6.04 million for every 1,000 Wal-Mart employees, according to data compiled by Bloomberg. Toys and sporting goods together represented only 6 percent of Wal-Mart's more than $256 billion in 2003 sales.

Results at Toys ``R'' Us International, which opened its first stores in Singapore and Canada in 1984 and now has almost 600 locations, have gained since 2001 partly because it faces less competition than locations in the U.S.

Babies ``R'' Us, which opened in 1996 and sells baby furniture, clothes and toys, had 211 stores in the U.S. as of Dec. 27. It has posted rising profit and sales as a baby boom fuels rising demand for supplies.

To contact the reporter on this story: Andria Cheng in Princeton at lcheng@bloomberg.net

Last Updated: March 17, 2005 09:37 EST