* GKN agrees to combine automotive business with Dana
* Part of efforts to fend off takeover by Melrose
* Melrose could be forced to raise bid (Updates with Melrose comment)
By Ben Martin
March 9 (Reuters) - GKN has struck a $6.1 billion deal to merge its automotive business with U.S. company Dana Incorporated in a move by the British engineer to fend off a hostile takeover by turnaround specialist Melrose Industries. FTSE 100-listed GKN said on Friday that it had agreed to combine its Driveline division with the Ohio-based maker of axles and driveshafts in a deal that gives GKN shareholders a 47.25 percent stake in the enlarged, U.S.-listed group.
The British company, customers of which include Fiat Chrysler and Volkswagen, will also receive $1.6 billion in cash while $1 billion of GKN's pension deficit will be transferred to the combined business.
It deals a blow to FTSE 250 group Melrose, which has been pursuing GKN since January, when the engineering group spurned its unsolicited cash-and-shares bid that at the time valued GKN at 7.4 billion pounds ($10.2 billion).
Melrose responded by turning hostile and taking its offer directly to GKN's shareholders, putting pressure on the engineer's newly appointed chief executive, Anne Stevens. The deal with Dana could now force Melrose to raise its bid. By 1300 GMT on Friday, which was the first closing date of its offer, Melrose had received acceptances from investors holding only 5.76 percent of GKN stock, the turnaround specialist said. It added that it was extending the offer until March 29.
GKN shares advanced 3.3 percent to close at 435.1 pence in London. That is higher than the level of Melrose's offer, which currently values GKN at about 414.8 pence per share based on the Melrose share price, which was up 4 percent at 224.7 pence.
Dana shares climbed 4.1 percent to $27.27.
"We might need to revisit our offer, I think that's what the market is telling us," a source close to Melrose said.
According to UK rules, Melrose has until March 19 to improve its bid. But because the Easter break truncates the timetable it effectively has until March 15 to sweeten its offer terms.
The deal with Dana "provides significantly greater value for GKN's shareholders than the Melrose offer", GKN said.
It added that the merger gives Driveline an enterprise value, which includes debt, of $6.1 billion, based on Dana's closing share price of $26.20 on Thursday. The tie-up is expected to deliver annual cost savings and other benefits worth $235 million within three years, it said.
Together with GKN's plan to sell its powder metallurgy business, the deal will leave the company focused on aerospace, supplying parts for aircraft including the Black Hawk military helicopter and Eurofighter Typhoon.
GKN was left vulnerable to bid approaches after two profit warnings in October and November that were caused by problems at its U.S. aerospace business and sent its share price tumbling.
Dana approached GKN late in 2017 and the pair began talks early this year, the British company disclosed on Friday. Its aerospace division has also attracted a number of suitors since January, but the GKN board decided their proposals undervalued the business and did not pursue them, the company added.
If the Driveline deal is successful Dana will become a UK domiciled company, though it will remain headquartered in Ohio and its shares will be traded on the New York Stock Exchange. It will also be led by James Kamsickas, Dana's current CEO.
GKN shareholders will need to approve the merger, which means they will have to weigh its merits against a Melrose deal.
That will include considering whether they want to hold a stake in New York-listed Dana or London-listed Melrose.
"Following the (Dana) transaction, GKN shareholders will own 47 percent of a $14 billion revenue global automotive group and will retain ownership of GKN's outstanding remaining businesses," said GKN Chairman Mike Turner.
However, Melrose argued that many GKN investors would neither wish nor be able to hold U.S. stock.
"A hasty sale of one of Britain’s most important businesses will leave it listed overseas, run by a foreign management team and rebranded as a U.S. business," Melrose Chairman Christopher Miller said.
"In our view it is structured in a way prejudicial to GKN shareholders’ interests."
Separately, the trustees of GKN's group pension said the arrangements agreed as part of the Driveline transaction provide "appropriate mitigation to the schemes".
Credit Suisse and Barclays are advising Dana, while the U.S. company's board is being advised by PJT Partners. GKN is working with JP Morgan, Gleacher Shacklock and UBS. ($1 = 0.7233 pounds)
Reporting by Ben Martin in London and Noor Zainab Hussain Editing by Keith Weir, Elaine Hardcastle and David Goodman