UPDATE 3-LVMH and Hermes call truce in "handbag war"
* LVMH and Hermes agree to end all litigation
* Peace deal ends four years of bitter legal warfare
* LVMH to give most of 23.2 pct Hermes stake to shareholders
* Shareholders to get one Hermes share for every 21 in LVMH (Adds details of deal, background)
PARIS, Sept 3 (Reuters) - A long and bitter battle that has gripped the luxury goods industry and pitted two of France's richest families against each other came to an unexpected end on Wednesday when LVMH and Hermes agreed to a truce.
Under the deal, LVMH - the world's No.1 luxury group, controlled by France's wealthiest man Bernard Arnault - agreed to relinquish most of its 23.2 percent stake in Hermes and not acquire any shares in its smaller rival for five years.
It effectively buried the possibility LVMH could make a full takeover bid for the 177-year-old maker of Birkin and Kelly handbags. Such a prospect had boosted Hermes's stock, which has been trading at a price-to-earnings ratios of about 30 times in recent years, a 70 percent premium to the industry average.
Shares in Hermes fell nearly 10 percent to 236.5 euros in early trading on Wednesday, wiping out 2.8 billion euros ($3.7 billion) off its market value - equivalent to around 350,000 Birkin handbags based on an average price of 8,000 euros . By market close, they were down 3.5 percent.
"The speculative premium has disappeared," said Barclays France director Franklin Pichard.
The deal, under which LVMH agreed to redistribute its stake in Hermes to its shareholders, ends four years of legal warfare between the luxury titans, dubbed the "handbag war" by the press.
In 2010 LVMH - whose brands include fashion labels Christian Dior and Louis Vuitton, Hennessy cognac and Dom Perignon champagne - revealed it had built up a 17 percent stake in Hermes. It made the investment through a series of equity derivatives instead of straightforward share purchases, which prevented it from having to declaring them.
Hermes, one of France's last major independent luxury group still controlled by the founding family, vehemently protested at having its arch-rival as its biggest external shareholder.
According to French magazine Challenge, the Hermes family is Frances's fourth richest with a fortune estimated at nearly 19 billion euros, behind LVMH's Arnaults - estimated at 27 billion euros, L'Oreal's Bettencourts and Auchan's Mulliez. They come just ahead of Chanel's Wertheimer brothers.
Arnault had long set his sights on Hermes as it is considered one of the luxury brands that best resists downturns, with its products increasingly regarded as investments and benefiting from a thriving second-hand market.
While the sales growth of rival mega-brands such as Gucci and Louis Vuitton have ground to a halt in the past year, Hermes has continued to enjoy an annual revenue rise of more than 10 percent, consistently higher than the industry average.
The deal marks the first time Arnault - whose LVMH group has gobbled up more than 60 brands in the past two decades, including sizeable ones such as Roman jeweller Bulgari - abandons the pursuit of a prized target.
But the truce nevertheless offers a profitable solution for LVMH, which began building up its stake in Hermes in 2007 and 2008. It stands to make a theoretical gain on its holding of around 3 billion euros, analysts estimated.
"This clears up the situation and it is one of the few divorces in which both the partners are winners," said Mario Ortelli, luxury goods analyst at Bernstein.
Groupe Arnault, the family holding company of LVMH, will own 8.5 percent of Hermes after the share distribution.
Arnault is a proven master at exploiting family tensions when trying to buy a company. When the dispute started in 2010, industry observers thought the billionaire would seek to apply the same technique to Hermes' more than 100 family shareholders, divided between the Puech, Dumas and Guerrands.
A year later, most key family members except Nicolas Puech, who owned just under 6 percent of Hermes' shareholder capital, agreed to join a holding that controlled the company and bound them for two decades, making a takeover virtually impossible.
"LVMH has found an elegant way out of what was a deadlock," JP Morgan Cazenove said of the peace deal.
LVMH shares, flat since Jan. 1, rose about 3 percent on Wednesday. LVMH stock has underperformed the luxury goods industry in the past year over concerns about declining cognac sales in China and slower sales growth at its main profit generator Louis Vuitton.
The French stock market regulator fined LVMH last year for failing to properly disclose the stakebuilding and Hermes launched legal action against LVMH on allegations of insider trading and stock price manipulation.
LVMH fought back with proceedings against Hermes for libel.
The agreement signed on Tuesday night ended all legal proceedings between the two companies, they said in a joint statement issued on Wednesday.
For 21 LVMH shares, shareholders will receive 1 Hermes share, sources close to LVMH said. The distribution of Hermes shares will be completed no later than Dec. 20. (Additional reporting by Andy Callus, Pascale Denis, Alexandre Boksenbaum-Granier and Blaise Robinson; Editing by Pravin Char)