* Woolworths says the move will simplify both businesses
* Demerger follows years of pressure over slot machines
* Woolworths shares rise to over 1-month high (Adds fund manager comment)
By Byron Kaye and Nikhil Nainan
SYDNEY/BENGALURU, July 3 (Reuters) - Australia's biggest supermarket chain Woolworths Group Ltd said on Wednesday it will combine and spin off its drinks and pubs units to focus on its core business, cutting back its contentious involvement in poker-machine gambling.
The demerger would give investors exposure to a standalone listed operator of 1,500 liquor stores and 327 pubs worth about A$10 billion ($7 billion), according to analysts, while reducing family-focused Woolworths' reliance on slot machine revenue.
It also marks the beginning of the end of the major retailers' addiction to poker machine revenue, after Woolworths rival Coles Group Ltd said in March it was carving off its pubs business into a joint venture.
"A significant proportion of the world's funds under management that would invest in this stock is concerned about its ownership of hotels and poker machines," said David walker, large companies portfolio manager at Clime Asset Management.
"Whether that's the intention or not, it just removes a hurdle."
Woolworths shares were trading 3% higher late on Wednesday, while the broader Australian market was up about 0.5%, a sign that investors supported the split.
Woolworths Chief Executive Officer Brad Banducci said the divestment was intended to simplify both businesses in response to fierce competition from internet-based retailers, not to allay investor concerns over gambling.
"We did it to unlock potential, not to avoid issues," he told journalists.
"There will be more simplicity which will lead to more agility," he said, adding Woolworths could sell the new asset rather than demerge.
The move comes two weeks after New South Wales state's gambling regulator said it was investigating a complaint that two Woolworths-owned pubs broke the law by giving gamblers free alcohol. The pubs and drinks units brought about a fifth of Woolworths' pre-tax profit in 2018, its annual report shows.
Woolworths' poker machine arm ALH is Australia's third-largest owner of slot machines with some 12,000 of them, behind only casino operators Crown Resorts Ltd and Star Entertainment Group Ltd.
Public concerns about the social costs of gambling - Australians lose about A$14 billion a year on poker machines - and the conversion of traditional pubs into gambling venues have dogged Australian retailers for years.
"ALH has long been Australia's biggest, most aggressive and most irresponsible pokies operator, pushing hard on loyalty schemes, offering up free liquor to gamblers and operating for the maximum amount of hours as the laws allow," Alliance for Gambling Reform head Tim Costello said.
Cutting its ties with slot machines was a "globally significant moment for the gambling divestment movement, not unlike Rio Tinto getting out of coal", he added.
The Australian supermarket sector is facing growing competition from internet rivals and aggressive discounters like Germany's ALDI Inc.
Last year, Woolworths said it was selling its petrol station business to Britain's EG Group for A$1.73 billion, and the former owner of Coles, Wesfarmers Ltd, spun off the No. 2 grocer. ($1 = 1.4306 Australian dollars) (Reporting by Byron Kaye in SYDNEY and Nikhil Kurian Nainan in BENGALURU, additional reporting by Aby Jose Koilparambil in BENGALRU; Editing by Stephen Coates and Himani Sarkar)