UPDATE 1-Prospect terminates offer to buy Allied Capital

* Says willing to engage in talks if Allied-Ares deal falters * Prospect says Allied unwilling to talk over potential deal

* Prospect up 2 pct, Allied up 3 pct to new yr-high

March 5 (Reuters) - Prospect Capital Corp (PSEC.O) terminated its unsolicited bid to buy rival Allied Capital Corp ALD.N, which is selling itself to Ares Capital Corp (ARCC.O), putting an end to the two month long proxy fight.

The termination follows Allied's plans to declare a special dividend of 20 cents a share if shareholders approve its merger deal with Ares. [ID:nSGE6220J9]

Prospect Capital, however, added if the proposed Allied-Ares deal does not go through and the Allied board was willing to engage in a productive dialogue, it will be interested in further talks.

Prospect and Allied were engaged in a bitter war of words after Allied rejected the initial bid and said it did not see it as a "superior proposal" over Ares Capital's offer. [ID:nSGE60I0JX]

Ares Capital has agreed to buy Allied Capital in an all-stock deal valued at $648 million. [ID:nBNG507417] [ID:nBNG534512]

(Reporting by Archana Shankar in Bangalore; editing by Akshay Lodaya)