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* Combining Peugeot and Opel would hit political opposition
* Merger would bring plant closures, job losses
* GM prepared to inject cash if it had control - source
* Peugeot burning cash as sales dive
* Peugeots one of three remaining Europe car dynasties
By Sophie Sassard, Laurence Frost and Gilles Guillaume
LONDON/PARIS, June 27 (Reuters) - PSA Peugeot Citroen's founding family has offered to give up control of the troubled French automaker as it tries to revive plans for a closer tie-up with General Motors backed by a fresh capital injection, sources said.
But any deal combining Peugeot with GM's European Opel division would face major political hurdles because it would bring more factory closures and job losses in France and Germany, people with knowledge of the discussions told Reuters.
The Peugeot clan, one of Europe's three surviving car dynasties, turned with beleaguered chief executive Philippe Varin to 7 percent shareholder GM after inconclusively sounding out other potential investors including Chinese partner Dongfeng, they said.
"GM faces the same overcapacity situation with Opel, and that's why PSA is trying to convince them to merge the two," said one of the people, who asked not to be identified because the talks are confidential. "The Peugeot family has now accepted that they'll lose control, so this is no longer an issue."
The Peugeot family, which founded the company in 1810 as a coffee mill manufacturer, holds a 25.4 percent stake that commands 38.1 percent of voting rights in a group that is now struggling for survival.
Both Peugeot and GM declined to answer questions about their frequent discussions. "We don't comment on speculation or rumours," Peugeot spokesman Jonathan Goodman said.
Before injecting more cash, GM would need assurances that it had a free hand to cut production capacity as it took control of integrating Peugeot and Opel, sources said.
Peugeot, its sister brand Citroen and Opel are among those worst hit by a European car sales slump that put a $1.8 billion dent in GM's 2012 earnings. The market is on course to contract for a sixth straight year taking sales to a two-decade low.
For Peugeot, heavily dependent on its home region, the threat is to its existence. The company burned 3 billion euros ($3.9 billion) in operating cash last year, and asset writedowns swelled its net loss to 5 billion.
Peugeot's shares have fallen 77 percent over the past two years, compared with a 1.4 percent slide for the STOXX Europe 600 autos & parts index. Its debt has been classed as junk by all of the main rating agencies since early 2012.
CEO Varin has responded by cutting 10,000 more jobs, selling 2 billion euros in assets and negotiating a 7 billion euro state guarantee for financing arm Banque PSA.
The company aims to cut more costs by pooling future car programmes with GM under their existing alliance - cemented by a 1 billion euro share issue when the U.S. auto giant acquired its Peugeot stake in March 2012.
Earlier talks on a full combination were halted late last year as a French government bailout of Peugeot and its worsening cash position stirred misgivings at GM's headquarters in Detroit.
Peugeot will need another capital injection and must lay the groundwork this year, people familiar with the matter said, even if the company sticks to its goal of halving operating cash consumption to 1.5 billion euros in 2013.
Exploratory discussions about selling a 30 percent stake to a consortium led by Dongfeng Motor Group were inconclusive, the sources said, and would anyway have taken too long. Dongfeng declined to comment.
"PSA will need to present a new industrial plan for people to underwrite a capital increase, and the only hope is GM," one said. "They (GM) are ready to inject more money if they can control the business, integrate Peugeot and Opel and rationalise production."
GM is "playing hard ball" by holding out for assurances that it would be able to cut plants and jobs at reasonable cost, another person said, adding that no plan is likely to surface before German elections in September.
The U.S. carmaker has drawn criticism from some shareholders over the initial Peugeot investment. GM halved the book value of its stake in a February writedown.
GM has no plans to put in more cash, Chief Executive Dan Akerson said last week, while leaving the door slightly ajar.
"We don't have any intention of investing additional funds into PSA at this time," Akerson told reporters in Shanghai. "If we see something changes, we'll evaluate that."
Walking away may not be an easy option either. GM's European turnaround plan draws on technology from vehicles such as the Peugeot 208 and Citroen C4 Picasso for future versions of the Opel Corsa small car and Zafira minivan.
But approval for sweeping cuts seems unlikely in Germany or France - where the government last year condemned Peugeot over plant and job cuts that President Francois Hollande described as "unacceptable".
As one of its rescue conditions, the French government appointed civil servant Louis Gallois to Peugeot's board. Gallois, a former CEO of Airbus parent EADS, declined to be interviewed for this report.
Ministers understand that Peugeot needs a fuller combination with GM or another industry partner and now expect Varin to present a new plan within months, a French official said.
While not "dogmatically" opposed to foreign control, the government remains determined to preserve Peugeot's French sites and jobs, he added.
The government or a state-owned investment vehicle could end up taking a Peugeot stake if necessary, officials have also suggested.
In the past five years, GM has scrapped a Belgian car factory and earmarked another for closure in Germany, where it has about 20,000 employees.
Peugeot, which employs 77,000 workers in France, is shuttering its Aulnay plant near Paris and scaling down another domestic site. Its five French assembly plants ran at 71 percent capacity in 2012, according to IHS Automotive data, while GM's three main German sites were at 66 percent.
Combining their European operations would require deep cuts to draw benefit from the considerable overlap between similarly sized and priced cars. GM sold 9.3 million vehicles globally last year and its French partner 3 million.
Peugeot also ended 2012 with cash of 6.67 billion euros, excluding listed subsidiary Faurecia, and is expected to consume 2 billion this year after restructuring costs.
Together with 2.4 billion euros in undrawn credit lines, that will leave about 7 billion in available reserves - but the real cushion is closer to 4 billion because Peugeot needs the difference just to operate.
"The minimum level of liquidity they need is 3 billion," said a London-based auto analyst with a major U.S. bank. "You never want to use that up."
At Peugeot's current market value of 2.2 billion euros, raising another 1 billion in equity would dilute current shareholdings by at least a third. The immediate effect could be reduced by issuing convertible bonds along with shares.
"The only way it works is with a family dilution," said one source.
Such an upheaval for the company would reduce Europe's remaining trio of car dynasties to a pair: BMW's Quandts and the Agnellis still reigning over Fiat.
Chairman Thierry Peugeot and his cousin Robert, who heads the family holding company, both declined to be interviewed. ($1 = 0.7691 euros) (Additional reporting by Soyoung Kim in New York, Ben Klayman and Deepa Seetharaman in Detroit, Christiaan Hetzner in Frankfurt, Matthieu Protard, Jean-Baptiste Vey and Julien Ponthus in Paris; editing by David Stamp)