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* J&J cuts stake in Elan via Irish firm's share buyback
* Elan buys back shares at $11.25 apiece
* Royalty had urged shareholders to tender at $11.75 or $12
* Result means Royalty will reduce its bid
* Traders bet on Royalty returning with better offer
By Padraic Halpin and Jessica Toonkel
DUBLIN/NEW YORK, April 18 (Reuters) - U.S. healthcare firm Johnson & Johnson cut its stake in Elan Corp on Thursday in a move that clouds prospects for a $7.3 billion takeover bid for the Irish drugmaker.
U.S. investment firm Royalty Pharma on Monday made an improved $12 per share bid for Elan, which has rejected its suitor's overtures and wants to remain an independent company.
However, that offer depended on the outcome of a $1 billion share buyback being conducted by the Irish firm.
Royalty had urged Elan's shareholders to tender shares at between $11.75 and $12 apiece and warned that if they did not, it would reduce its offer.
Elan said on Thursday it had bought back the targeted amount of stock at the bottom of its indicative price range of $11.25 to $13, with Johnson & Johnson (J&J) accounting for 92.3 percent of all shares purchased.
J&J, whose stake in Elan has fallen to 4.9 percent from 18 percent, did not give a reason for selling shares in Elan, but said it would make a $213 million gain on its 2009 investment.
Royalty said that as a result of the pricing of the buyback, it would lower its offer for Elan to $11.25 a share.
At 1740 GMT, however, Elan's shares were up 0.2 percent at $11.9 in New York. Analysts were divided whether this signalled confidence in Elan's management, or speculation that Royalty would eventually return with a higher bid.
"It's a strong message that the shareholder base of Elan is not thinking about tendering at the $13 level," said Berenberg Bank analyst Adrian Howd, referring to the top end of the price range proposed by Elan for its share buyback.
Elan sold its 50 percent interest in lucrative multiple sclerosis drug Tysabri for $3.25 billion plus future royalties to U.S. partner Biogen Idec in February, and wants to spend the bulk of the money on acquisitions.
Royalty argues Elan's management does not have a track record of deals, and has urged the Irish firm's shareholders to accept its cash offer. It wants to add the royalty rights to Tysabri - worth hundreds of millions of dollars annually - to its large stable of royalty streams.
Elan said just 4 percent of shares were tendered in the price range recommended by Royalty.
Mirabaud Securities analyst Nick Turner was surprised more Elan shareholders had not tendered shares towards the top end of the indicative range.
"Whether they believe they can get a better return out of Elan under current management ... that is not an argument that holds water with me," he said.
The volume of Elan shares changing hands had more than trebled by late morning trading in New York compared with the day before, which some analysts saw as a sign that dealers are still hoping for a higher bid for the company.