UPDATE 5-Activist shareholders raise their stakes in Navistar

* Franklin Resources now top holder with 18.8 pct stake

* MHR, Icahn holdings shy of poison pill trigger point

* Franklin cannot raise stake without triggering pill-Navistar

* Key question is if investors working together, observers say

* Weak demand in U.S., slowing growth abroad hurting demand

By Scott Malone

July 12 (Reuters) - Three big investors have increased their stakes in embattled U.S. truck and engine maker Navistar International Corp, which last month surprised Wall Street with a quarterly loss and has since backed down from a new engine technology it was pushing.

Asset manager Franklin Resources Inc is now Navistar's largest shareholder, with an 18.8 percent stake, topping MHR Fund Management and billionaire Carl Icahn. MHR last month took a significant stake in the company and now holds 14.95 percent; Icahn holds 13.19 percent.

Together, the three top shareholders hold almost 47 percent of the outstanding shares of the maker of International-brand heavy trucks and school buses.

Those larger stakes could set the stage for investors to pressure Navistar - whose market value has fallen almost 40 percent this year - to move quickly to improve its performance in a year when analysts expect it to lose money.

"I think there are a lot of back-room meetings going on," said Gimme Credit analyst Vicki Bryan. "They might be trying to work together to forge alliances that Navistar's management is not able to get accomplished."

MHR, founded by Mark Rachesky, declined comment, while Icahn and Franklin Resources did not respond to requests for comment.

Navistar Chief Executive Daniel Ustian and Troy Clarke, the company's recently appointed president of trucks and engines, last week laid out a change in engine strategy that failed to impress investors. After months of failing to win U.S. regulatory approval for a novel technology to cut emissions, Navistar said it would adopt the approach used by most of its rivals, including Cummins Inc and Paccar Corp : using liquid urea to help cut emissions of nitrogen oxide, a pollutant linked to asthma.

Navistar said a new engine it is developing would be ready by early next year, but investors fear its sales will suffer in the meantime.

Navistar shares were up 3.4 percent to $23.79 in afternoon trading on the New York Stock Exchange.

UP AGAINST THE POISON PILL

Navistar in June adopted a "poison pill" intended to keep any investor from acquiring a 15 percent or greater stake in the company.

Franklin Resources took its higher stake, which it disclosed in a filing with the U.S. Securities and Exchange Commission, prior to Navistar adopting the poison pill, Navistar said.

"They acquired all those shares prior to the adoption of the poison pill. There is no issue there," said Navistar spokeswoman Karen Denning. But she also said the poison pill would prevent Franklin Resources from buying more shares.

The MHR and Icahn stakes remain below the 15 percent trigger level.

Navistar's board adopted the poison pill to prevent a hostile takeover. It would allow existing investors with less than a 15 percent stake to buy new shares in the company at half price, which would dilute the holdings of anyone with more than 15 percent.

Charles Kane, a senior lecturer in finance at the Massachusetts Institute of Technology's Sloan School of Management, said it was likely that Icahn and MHR were working together informally. He said he has served on corporate boards where activist investors appeared to team up to try to influence management.

"They all get together, they all work in unison, and that way they can have more impact," said Kane, who has served on the boards of a number of tech companies that have been approached by activist investors, including Netezza Corp, which was acquired by International Business Machines Corp in 2010. "I'm not sure that this kind of poison pill is effective against activists."

HITTING THE BRAKES

Navistar shareholders got more to worry about earlier this week when engine maker Cummins warned it no longer expects to be able to grow sales this year, as demand for trucks weakens in the United States and fails to improve in the key emerging markets of Brazil, China and India.

That news pulled down the shares of big U.S. truck and engine makers including Cummins, Navistar, Oshkosh Truck Corp and Paccar.

"The market has been weak in North America and now is slowing in China and Brazil," said Robert W. Baird & Co analyst David Leiker. "There are a couple of tough quarters ahead for heavy trucks."

Navistar has been facing pressure from investors to sell itself or change its engine strategy. It has struggled for the past year to contain costs of developing a new type of diesel engine for heavy trucks.

Icahn, who also owns 9.5 percent of Oshkosh, last year pushed for a merger of that company and Navistar. Navistar CEO Ustian was open to a deal, but Oshkosh shareholders fought off Icahn by voting down a slate of directors he had nominated at the company's January shareholder meeting.

Analysts have suggested that Navistar could be sold to a European or Chinese truck maker. Fiat Industrial SpA CEO Sergio Marchionne in June publicly flirted with the idea, but early this month one of his deputies said Navistar's engine strategy was "completely different" from Fiat's approach.

One major factor that could scare off potential buyers is the continuing review of Navistar's engines by the U.S. Environmental Protection Agency. Until the EPA certifies that the engines meet current emissions standards, potential buyers will remain wary of a deal, according to sources familiar with the situation.

MHR's Rachesky worked for Icahn before starting his own investment firm. His company is the largest shareholder of film studio Lions Gate Entertainment Corp, a position it firmed up last year after Icahn gave up a long battle to take over the company.

The 39 percent slide in Navistar shares this year has been far steeper than the declines at its peers. Oshkosh is down 6 percent; Cummins, 5 percent; and Paccar, 4 percent.