* Weir proposes 60-40 split in new company - source
* Top Metso shareholder, state fund Solidium, spurns deal
* Metso shares still up 19 percent in afternoon trading
* Deal would help Weir expand into crushing (Adds Finnish state holdings view, detail on strategy)
By Jussi Rosendahl and Sophie Sassard
HELSINKI/LONDON, April 1 (Reuters) - British engineering company Weir Group has approached Finnish rival Metso over a possible $5 billion combination that would expand its mining business, but Finland's state investment fund said it opposed a takeover.
Weir has proposed an all-share deal in which Metso shareholders would receive 40 percent of the new company and is offering a 5-10 percent premium over Metso's recent share price, a source familiar with the matter told Reuters.
The source said the approach was structured as a merger in which Weir shareholders would end up with most of the combined entity but the new company's board would be staffed with both Metso and Weir executives.
The result would be a "stronger Finnish company" and "the proposed structure through an all-share merger will allow existing shareholders to benefit from the huge synergies," the source said.
But the head of state investment fund Solidium, which owns 11 percent of Metso, rejected a takeover of Metso, saying it had a bright future as an independent company.
"I don't think this is the right time to sell Metso to Weir Group, or to sell it to anyone," said Solidium managing director Kari Jarvinen.
Metso shares were up 19 percent at 28.18 euros by 1548 GMT, suggesting investors still believed some kind of deal was possible. Weir was down 1.3 percent.
One hedge fund investor who closely follows Finnish deals said such a public rebuttal by the state fund appeared to have stopped any deal in its tracks.
A London-based Finnish analyst agreed, saying: "I think it's quite a strong comment and I'm surprised the market hasn't reacted to it".
"What the market maybe misses a little bit is that Metso is the backbone of Finnish industries. It has a pretty important supply chain and there is in the investor base a lot of retail investors," the analyst added.
EXPANSION IN SERVICES
A deal would help Glasgow, Scotland-based Weir expand further into the crushing segment of the mining equipment industry, where Metso is a market leader.
Like Weir, Metso has a growing focus on services, which have become increasingly important after mining companies cut back on new projects and stopped buying new equipment to reduce costs.
Weir said it had made an "indicative all-share merger proposal" to Metso's board after the Times newspaper reported that Weir was interested in a deal. Metso said no talks had yet taken place and it was considering the proposal.
A tie-up could be worth as much as 3.9 billion euros ($5.4 billion) based on Metso's closing share price on Monday and a 10 percent bid premium.
Metso spun off its paper machine business Valmet at the start of the year, basically halving the size of the company and making it a more attractive acquisition target, analysts said.
Weir's approach helped to pull up other companies in the sector, with Danish engineer FLSmidth up 5.6 percent on hopes of further industry consolidation.
The Finnish state's Metso holding dates back to 1946, when state-owned metal workshops were merged as Valmet Oy. Following several mergers and acquisitions, these became Metso in 1999.
Finland's government had recently said it could sell stakes in some companies before 2015 to boost its budget by 1.9 billion euros. The state holds stakes in 15 of Helsinki's listed firms and controls 44 others.
Weir Group has seen profits triple since 2009 as the firm expanded into the U.S. and capitalised on the growth of shale oil and gas. The company now supplies around 40 percent of the pressure pumps used in the U.S. shale oil and gas sector.
But historically Weir's focus has been on the mining sector, which still accounts for over half of its revenue, and analysts said a move for Metso could mark a strategic turn back to its core market.
"From a strategic sense it looks reasonably sensible. The core business has always been on the minerals side," a London analyst said.
Weir has frequently been the subject of takeover speculation itself, and one banking source familiar with the situation said the move was partly designed to shrug off would-be buyers. "It's clearly aimed at ensuring their independence and it would be a good move for them," the source said.
Juha Kinnunen of Inderes Equity Research noted that buying Metso would be a big step for Weir, which has a market value of 5.4 billion pounds ($9.0 billion), compared with Metso's 3.6 billion euros.
"The two could have quite good synergies. They could expand their offering to the same customers."
Weir Group hired Bank of America Merrill Lynch and UBS to advise it on the potential deal, while Metso was working with Morgan Stanley, said a source who asked not to be named because the talks are private.
Metso's biggest shareholder is Swedish activist fund Cevian Capital, whose co-founder Christer Gardell sits on Metso's board. Gardell was among the first investors to promote this year's split-up of Metso as early as 2005. ($1 = 0.5998 British Pounds) ($1 = 0.7256 euros) (Additional reporting by Anjuli Davies; writing by Stephen Eisenhammer in London; editing by Tom Pfeiffer)