UPDATE 4-SAfrica's Sappi buys M-real graphic paper unit

(Adds fresh comments, updates shares)

By Tarmo Virki

HELSINKI, Sept 29 (Reuters) - Finland's M-real Oyj (MRLBV.HE) is selling its loss-making graphic papers business to South Africa's Sappi Ltd (SAPJ.J), in a first big step towards a long-awaited European paper industry consolidation.

Shares in M-real closed 18 percent higher at 1.24 euros, having risen as high as 1.39 euros, after Sappi said it would pay a total of 750 million euros ($1.1 billion) for the struggling unit including its debt.

"This makes sense. Their balance sheet position has been very weak, so this is more than welcome, especially in this very difficult financial environment," said Pohjola Bank analyst Henri Parkkinen.

"The acquisition price was quite good, at least when compared with my estimates which were a bit lower."

Consolidation rumours have long bubbled in the European paper sector, which has suffered from years of price-crimping overcapacity, but the M-real graphic paper deal is the first major transaction for years.

"M-real will now become ... a clearly more focused board and paper company with a strong core in high-quality packaging boards," said M-real Chief Executive Mikko Helander.

"The transaction signed today shows our commitment to improving the operating environment of our industry as a whole."

Sappi will pay 500 million euros in cash and assumed debt, 200 million in a vendor loan note and 50 million in new shares in Sappi. It expects to raise the cash through a 450 million euro rights offering.

M-real said the deal will cut its annual sales by about 1 billion euros, while its net debt will fall to 630 million euros.

DECENT PROFITS

"The deal takes their gearing down to just over 70 percent -- It is still high, but ... it definitely reduces the balance sheet risk," said Swedbank analyst Claes Rasmuson, referring to the level of M-real's debt to its equity capital.

"They are getting closer to having cartonboard as their main product area and that is actually an area where they are having decent profitability, so it's improving their outlook."

Analysts said Sappi was one of the few companies in the market who should be able to turn the loss-making graphics paper business around. The unit lost 30 million euros in the first half of 2008, but Sappi is aiming to reach annual synergies of 120 million euros over the next three years.

"We anticipate that the acquisition will increase profitability, resulting in better returns and improved cash flows for the group," Sappi CEO Ralph Boettger said.

The sale includes the Kirkniemi and Kangas mills in Finland, the Stockstadt mill in Germany and the Biberist mill in Switzerland, with total capacity of 1.9 million tonnes.

Rating agency Standard & Poor's raised Sappi's outlook to stable from negative in the wake of the news.

M-real will take a 225 million euro ($329 million) writedown on the sale, but Helander said he saw no risk to the company's loan covenants.

The cost of insuring M-Real's debt against default, or its credit default swaps, fell by about 200 basis points to 1,100 basis points, a trader said.

M-real's Helander told Reuters the picture was mixed on the pricing front for his company.

"In papers, we have finally seen positive price developments. It seems that momentum has changed," Helander said on the sidelines of a news conference on the Sappi deal.

"However, cost inflation has been for the last three years at a record high level. Due to that reason the achieved price increases are not enough. We definitely need more." (Additional reporting by Agnieszka Flak and Brett Young in Helsinki, Johan Ahlander in Stockholm and Natalie Harrison in London; Editing by David Holmes)