* World's No. 2 coffee chain
* Whitbread was under pressure from activist investors
* Costa has attractive international opportunities -CEO (Adds Elliott views, background on industry acquisitions)
By Paul Sandle and Rahul B
LONDON, April 25 (Reuters) - Costa Coffee will be spun off after parent Whitbread yielded to pressure from hedge funds who argued it was being held back by being grouped with the Premier Inn hotel chain.
The world's second biggest coffee chain after Starbucks Corp has attractive, long-term international potential, Whitbread said.
Former brewing group Whitbread will retain its Premier Inn hotels and Beefeater and Brewers Fayre restaurants once the split is completed within 24 months, a timeline which some shareholders said was longer than necessary.
Activist investors Paul Singer's Elliott Investors and U.S.-based Sachem Head had pressured the British company to split itself up to help unlock value.
"We are confident that both Premier Inn and Costa will soon be businesses of sufficient strength, scale and capability to enable them to thrive as independent companies," Whitbread Chief Executive Alison Brittain said.
Shares in the group, founded as a brewer in London more than 200 years ago, were unchanged at 41.86 pounds at 1250 GMT. That values the company at around 7.7 billion pounds ($10.7 billion).
They have hit one-year highs in recent days after reports said CEO Brittain believed a spin-off was inevitable.
Morgan Stanley analysts said the demerger could trigger takeover interest in Costa, which they valued at about 2.6 billion pounds.
With potential takeover interest from the likes of JAB, Restaurant Brands, Yum Brands or Nestle, Morgan Stanley said Costa could fetch 10 percent more than that.
Analysts at brokerage Stifel wrote in a note that a buyer for Costa, with the ability to accelerate its international expansion, may emerge before the separation of the business.
Ed Meier, a manager of the Old Mutual UK Equity Income Fund, a Whitbread investor, welcomed the move, but not the 24-month timeline.
"As long-term shareholders in Whitbread we feel this is the right decision to maximise shareholder value over the medium term, though we sense allowing 24 months for the process is longer than most would have anticipated," he said.
Elliott Advisors, in a statement, said it was pleased that Whitbread had announced a demerger and committed to doing so "as fast as practical" adding it that believes a demerger could be achieved within six months.
A source familiar with Elliott's plans called the 24-month timeline "extreme".
Dealing with the Whitbread pension fund would be a major factor in completing the demerger, Canaccord Genuity analysts said in a note.
The pension fund had an accounting deficit of 289 million pounds ($403 million) as of March.
Other demergers have taken far less than two years, such as Reckitt Benckiser Group and Indivior, which took five months, and Cookson Group and Alent, completed in under two months.
Costa, founded in London in 1971, has expanded rapidly since it was acquired by Whitbread in 1995. It now has more than 2,400 shops in Britain, over 1,400 stores in 31 international markets and over 8,000 Costa Express self-serve units.
Since taking the helm in 2015, CEO Brittain has driven Costa's expansion in China, a market where Costa's only larger rival Starbucks is planning to more than triple its over 3,000-store network within a decade.
"Costa will become a listed entity in its own right and the clear market leader in the out-of-home coffee market in the UK," she said.
"Costa will also be well positioned to build further on its strong international foundations with growth expected in China and Costa Express."
However, over the last two years, Whitbread, like many other consumer-focused companies in Britain, has felt the pinch from higher inflation and low real wage growth in its home market.
Costa's like-for-like sales in its British stores slipped 0.3 percent in the final quarter of the year, it said on Wednesday.
Whitbread reported a 4.5 percent rise in underlying annual profit before tax to 591 million pounds, beating a company-compiled forecast of 585 million. Costa had underlying operating profit of 159 million pounds.
($1 = 0.7167 pounds) ($1 = 0.7174 pounds)
Reporting by Paul Sandle in London and Rahul B in Bengaluru; additional reporting by Sarah Young, Simon Jessop, Maiya Keidan and Martinne Geller; editing by Keith Weir and Jason Neely