* Bayer says outbidding Reckitt would not meet M&A criteria
* Reckitt offering $1.4 bln, above Bayer's $1.2 bln
* Reckitt in communication with Schiff, hopes for agreement
* Bayer says to continue looking for bolt-on acquisitions
* Schiff shares fall below $42 in pre-market trading
FRANKFURT/LONDON, Nov 20 (Reuters) - Bayer has surrendered U.S. vitamin maker Schiff Nutrition to rival bidder Reckitt Benckiser, in a blow to the German drugmaker's quest to grow through smaller takeovers.
Bayer's decision to quit the fight on Tuesday vindicated last week's move by Reckitt to offer $1.4 billion for Schiff, topping an agreed $1.2 billion deal Bayer had struck.
Reckitt, the British consumer products group behind Cillit Bang cleaner and Durex condoms which launched a tender offer for Schiff on Nov. 16, said it now hoped to clinch an agreement with Schiff management.
"Our original tender offer still stands and we look forward to reaching an agreement," a spokeswoman said. "We are in communication with them (Schiff)."
Reckitt is offering $42 per Schiff share, a 24 percent premium to the $34 Bayer agreed to pay on Oct. 30.
Schiff shares, which closed at $44.15 on Monday on hopes for a bidding war, traded down to $41.76 in premarket trade.
Bayer, German biggest drugmaker, said its board decided not to increase its offer because outbidding Reckitt would not make financial sense.
"Entering a competitive bidding process ... would result in a price outside Bayer's set financial criteria."
Bayer plans to continue a strategy of augmenting growth from existing operations with strategic bolt-on acquisitions.
FIGHT FOR SHELF SPACE
For Bayer this is a setback as it aims to challenge U.S. group Johnson & Johnson for the No.1 position in the global over-the-counter (OTC) drugs market in the longer term.
Many pharmaceutical companies are keen to expand in non-prescription drugs as a steadier, albeit less profitable, counterweight to prescription medicines where there are risks of, for example, clinical trial failures and patent expiries.
Reckitt's move showed the OTC drug industry also appeals to household goods makers as they fight to command more shelf space in drugstores and supermarkets.
The company is paying a high price to get into the $30 billion global market for vitamins and supplements for the first time - its offer works out at 16.5 times the $85 million of earnings before interest, tax, depreciation and amortisation (EBITDA) Schiff expects to make in the year to May 2013.
That would be roughly double the multiple Carlyle paid for supplements maker NBTY two years ago.
Reckitt, however, has a track record of achieving cost savings and sales synergies. Past successful takeovers include its acquisition of Boots's OTC drugs business, cough medicines company Adams, and Durex condoms group SSL.
Reckitt has said it expected the deal to boost earnings immediately on an adjusted basis.