* Cevian says decision to keep Power Grids "unfortunate"
* ABB raises margin target for Power Grids
* ABB sees profit potential in software, consulting (Adds comments from shareholder Nordea, updates shares)
By John Revill
ZURICH, Oct 4 (Reuters) - ABB will keep its Power Grids business in a rejection of demands from an activist investor to spin it off and the Swiss engineering group has also unveiled plans for a $3 billion share buy back from next year.
The Zurich-based company's long-awaited decision disappointed Cevian Capital, ABB's second biggest shareholder, which had wanted Power Grids to become a separate entity. Investor AB, ABB's largest shareholder, backed the decision to hold on to it.
ABB said on Tuesday it had made this choice to take advantage of trends like smart grids and linking renewable energy production to consumers and that this was a better option than selling, floating, or spinning off the business.
Cevian Capital, which has a 6.2 percent stake in ABB, was disappointed.
"ABB is a collection of top-quality businesses whose performance has been hindered for many years by the company's conglomerate structure," Christer Gardell, Cevian's Managing Partner & co-founder, said.
Cevian said separating ABB and Power Grids, which makes parts for offshore wind turbines, could create two companies with combined share price of 35 Swiss francs ($35.80).
"The board has decided to keep the conglomerate structure. We think this is an unfortunate decision. The board and management team will be held accountable for realising 35 francs," Gardell said.
ABB's shares, which despite a recovery in 2016, have lagged rivals like General Electric, Siemens and Legrand over the past five years.
ABB's shares were up about 0.8 percent at 22.14 Swiss francs at 13.02 GMT.
ABB Chief Executive Ulrich Spiesshofer said he had had a "friendly and open" conversation with Cevian early on Tuesday, without giving further details.
"Cevian and ABB have a lot in common," he told reporters. "We will drive a lot of value creation for our shareholders."
Chief Financial Officer Erik Elzvik said it would be possible for ABB to increase its share price to 35 Swiss francs, but did not give a time frame.
Power Grids is the least profitable of ABB's divisions due partly to its involvement in low margin projects. Competition has also forced down prices of products like transformers, also hitting margins.
Profitability has improved this year as a result of linking with partners to share the risk on projects and a greater focus on product supply rather than engineering, procurement and construction management services.
Nordea, another shareholder in ABB, said the decision to retain Power Grids meant the company's management had to deliver and improve its performance.
"Now that they have decided to keep it, it increases pressure on them to show the benefits and grow faster and be more profitable than their competitors," John Hernander, portfolio manager at Nordea Asset Management, said.
ABB said it was raising its margin outlook for Power Grids to a range of 10 to 14 percent from 2018, from a previous target of 8 to 12 percent. This would be achieved by focusing on higher-margin consultancy services and software.
Spiesshofer said he saw potential because the power grids market was growing at around 3 percent per year, but some parts were growing much faster.
Investor AB CEO Johan Forssell said: "We see no reason to jeopardise the strong momentum, for example, when it comes to cost savings and the turnaround of the systems part of Power Grids, the company enjoys by breaking it up."
"Secondly, we believe that ABB is more worth kept together than divided into pieces. We simply believe that the separation costs outweigh the positive aspects of a breakup, and we believe that ABB is a good owner of the business."
ABB, which announced its plans at an investor day on Tuesday, said the share buy back programme would run from 2017-2019. ($1 = 0.9776 Swiss francs) (Reporting by John Revill and Zurich Newsroom, additional reporting by Simon Johnson and Johannes Hellstrom; Editing by Christian Schmollinger and Jane Merriman)