* Deal values Diana Group around 1.3 bln euros, inc debt
* To create world No.3 scents and flavours firm
* Symrise may increase capital by 10 pct to fund deal
* Shares in Symrise fall 2.5 pct (Adds comments by CEO, analyst, background)
By Marilyn Gerlach and Natalie Huet
FRANKFURT/PARIS, April 14 German scents and flavours group Symrise is to buy France's Diana Group for an agreed 1.3 billion euros ($1.8 billion) including debt to narrow the gap on top rival Givaudan and expand in natural ingredients and pet food.
The purchase from private equity group Ardian will make Symrise the world's third-biggest scents and flavours company, up from number four, and help it toward a goal of boosting annual sales by around 1 billion euros by 2020.
Symrise Chief Executive Heinz-Juergen Bertram told reporters on Monday the firm would likely finance the deal via a 10 percent capital increase, as well as a mix of debt and equity.
Based on Symrise's current share price, a sale of 10 percent of its stock would generate around 400 million euros. The acquisition should start adding to earnings per share from 2015 onward, Symrise said.
"We think that the acquisition, although not cheap, makes strategic sense for the company," Berenberg Bank analyst Evgenia Molotova said in a note to clients, saying Diana had a very strong market position in natural ingredients as well as in the lucrative pet food market.
The deal values Diana at 14 times its 2013 earnings before interest, tax, depreciation and amortization (EBITDA).
Reuters last month reported that Diana had attracted bids worth more than 1.2 billion euros including debt from Symrise and Japan's Ajinomoto. The sources said buyout firms CVC Capital Partners, Eurazeo and Pamplona were also in the race for the company.
Shares in Symrise were down 2.5 percent to 34.95 euros at 1435 GMT.
Symrise makes flavours and fragrances used in goods such as drinks, ice cream and perfume, competing with Givaudan, unlisted Firmenich and International Flavors and Fragrances.
It has sought growth partly via acquisitions, buying the global fragrance business of New York-based Belmay Group last year and boosting its stake in Swedish probiotics company Probi last month, and has also pursued a strategy of increasing control over its own supply chain.
For instance, it has plans to set up a new production plant for vanilla extraction in the remote jungles of Madagascar this year and to expand capacity for its flavours and nutrition business in Shanghai next year.
CEO Bertram said Diana's strength in processing natural products would also help meet Symrise's target to address the growing demand for traceability of its products.
Diana is one of the world's leading providers of natural extracts from fruits, vegetables, fish, meat, wine and vinegar and is the global leader in palatability enhancers for pet food.
Symrise did not say how much of the transaction value was composed of debt. Ardian bought Diana from Cognetas in 2007 for 710 million euros including debt. Since then, staff and revenue have nearly doubled - Diana had 2,000 employees in 23 countries and sales of 451 million euros last year.
Symrise finance chief Bernd Hirsch said he expected Symrise to keep its investment grade rating because its ratio of net debt to EBITDA would rise only to 3 times compared with the current 2.2 times.
"I expect the balance sheet will remain very strong, also with enough flexibility and well positioned for further M&A activities and for other growth initiatives," Hirsch said.
CEO Bertram ruled out more big acquisitions in the medium term, but added Symrise would be open to smaller bolt-on deals.
Symrise had 1.83 billion euros in revenue last year, and combined with Diana, the new group will have pro-forma sales of 2.26 billion euros. Givaudan had sales of 4.37 billion Swiss francs ($4.99 billion).
JP Morgan and Lazard advised Ardian on the sale. Stamford Partners LLP advised Symrise.
($1 = 0.7201 euros)
($1 = 0.8759 Swiss Francs) (Editing by Andrew Callus and Mark Potter)