* JAB will sell illycaffe coffee pods under licensing deal
* New illy pods will be compatible with Nestle's Nespresso system
* Partnership does not entail equity investment by JAB in illy (Recasts to add Nestle comment and analyst comment)
By Francesca Landini
MILAN, Oct 8 (Reuters) - Italian coffee maker illycaffe and conglomerate JAB Holding have joined forces to produce and sell illy-branded coffee pods that will work in rival Nestle's Nespresso machines.
The licensing agreement is the latest move in a battle for consumers ready to pay more for higher-quality coffee.
The deal will allow JAB Holding to offer a new premium brand on the rival Nespresso platform and to further exploit its own distribution network.
Medium-sized illycaffe, meanwhile, will be able to grow its European business by teaming up with JAB-owned Jacobs Douwe Egberts (JDE).
"Illycaffe has struck a licensing deal with JAB's JDE under which JDE will sell aluminium capsules containing coffee produced by illycaffe," said CEO Massimiliano Pogliani on Monday, declining to provide financial details.
The deal follows Nestle's own $7 billion licensing agreement with Starbucks, announced in May, and Coca-Cola's August acquisition of coffee chain Costa.
"Competition is nothing new for Nespresso. In fact, we believe it pushes us to be even more innovative," a spokeswoman for Nestle said when asked about the deal.
Nestle is confident that it will continue to earn the loyalty of customers through high quality coffee and commitment to sustainability, she added.
JAB, the private holding company of Germany's Reimann family, has built a coffee empire over the past five years, seeking to beat market leader Nestle by buying packaged brands like JDE and coffee house chains like Peet's Coffee.
It also owns Keurig, the leading single-serve brewer system in the United States, which last January agreed to buy juice and soda maker Dr Pepper Snapple group.
"The new deal ties in with the strategic rationale for the Keurig-Dr. Pepper merger: it leverages its distribution network to sell a broad portfolio of brands, a key success factor in beverage markets," said Stanislas Duquesnoy, senior credit officer at Moody’s and lead analyst for JAB.
Monday's agreement will see Trieste-based illycaffe produce its blend for capsules that JDE will sell outside Italy.
Illycaffe, a brand that produces only one blend made from nine varieties of Arabica beans, is Italy's third-biggest coffee maker with sales of nearly 500 million euros ($574 million).
Illycaffe's existing pods work only with the Italian brand's own coffee machines, but Nespresso compatibility would open up the wider European market, where the Nestle machine holds a very strong market position.
The Italian brand also makes capsules that work on the Keurig system, but the production of these pods will not be included in the accord.
The new partnership will start in the first half of next year, with JDE initially selling the pods in Germany, France and Spain.
"The coffee pods segment is still booming, with a rate of growth of between 20 and 30 percent [a year]," said JDE's finance chief Fabien Simon.
Recent media reports said that the Illy family had rebuffed an offer from JAB to buy the coffee group they own. However, JDE's Simon on Monday denied that such an offer had been made.
Illycaffe Chairman Andrea Illy said the company was being courted by bigger rivals but wanted to remain independent and was not ready for a stock market listing. ($1 = 0.8716 euros)
Additional reporting by John Revill in Zurich, writing by Agnieszka Flak Editing by David Goodman