* Mead Johnson and Danone to compete together - sources
* Nestle tipped as favourite as it plans to bid alone
* Next bids due March 5 for $10 billion business
* Heinz could pick up stray pieces
By Jessica Hall and David Jones
NEW YORK/LONDON, Feb 24 (Reuters) - Mead Johnson and Danone have teamed up to bid for Pfizer's $10 billion infant nutrition business, pitting them in a two-horse race against Nestle in the next auction round due March 5.
Mead and Danone have secured Pfizer's permission to bid together after weighting up a joint approach for several weeks in a move to boost their firepower and allow them to overcome antitrust concerns, sources familiar with the situation said.
As the auction becomes a straight fight between Nestle and a Mead-Danone combination, banking sources and analysts tipped the Swiss giant as it has greater financial resources and would be easier for Pfizer to deal with.
"This is now a two-horse race and we see Nestle as clearly in the lead as it has deeper pockets while dealing with a single bidder will be easier for Pfizer to swallow," said one investment banker involved in the auction on Friday.
The Mead-Danone combination has reduced potential bidders from four after Heinz signalled its retreat to the sidelines as the world's biggest drugmaker looks to separate off this non-core business as early as July this year.
"We do believe the Pfizer asset may well be Nestle's to lose and any antitrust considerations could ultimately work to the favour of other infant nutrition competitors," said Barclays Capital analyst Jane Gelfand.
The Swiss giant will have to sell off portions to avoid competition issues, so Gelfand believes Heinz would be interested in Pfizer's Latin American business as Nestle is already very strong in infant nutrition in the continent.
Pfizer put its infant nutrition business up for sale last July following its $68 billion purchase of Wyeth in 2009. It is also weighing the future of its animal health business, and has said any separation of these two units would occur between July 2012 and July 2013.
The Pfizer unit is a high growth business with about $2.1 billion in annual revenues, built on its top SMA Gold brand. Some 60 percent of sales are in Asia, 30 percent in Europe, largely Britain, and 10 percent in Latin America.
It ranks number five globally in the infant milk formula market - the world's fastest-growing packaged food category - after Nestle, Mead Johnson, Danone and Abbott Laboratories with a quarter of sale in the buoyant Chinese market.
The $6 billion Chinese market is key as it is set to double to $12 billion by 2016 having grown at more than 20 percent a year over the last five years to feed 16 million new births a year. Mead leads the Chinese market with a 16 percent share followed by Danone with 14 percent, while Pfizer is fifth with a 8 percent share and Nestle has just 4 percent.
Analyst Pablo Zuanic at Liberum Capital says both Danone and Nestle would like the Pfizer business in China as Nestle has little presence in baby formula there while Danone could bulk up the premium and super premium part of its portfolio in the country.
Looking at the Mead-Danone combination, he said, "We take this to mean Mead Johnson prefers a larger Danone in China than to open the door to Nestle."
One source, who declined to be named because he was not authorized to speak to the media, said: "Joint bids add extra complications. Regulators will need to see a full plan on how things will be divided."
Both bidders would face antitrust hurdles. Nestle is likely to have to sell businesses accounting for 25 percent of the Pfizer unit's sales by disposing of interests in Latin America, Australia and South Africa. Danone might have to sell operations representing 30 percent of the unit's sales including in Britain and Ireland, presumably to Mead.
Sources said regulatory scrutiny is a major concern in this auction in the wake of recent tough antitrust moves. European antitrust authorities scuttled Deutsche Boerse AG's planned combination with NYSE Euronext and U.S. antitrust regulators led to the collapse of the AT&T Inc-TMobileUSA deal.
Chief Executive of the Pittsburgh-based Heinz, William Johnson has said he would not "bet the ranch" on big acquisitions in infant nutrition and has told analysts he would look at portions of the Pfizer businesses that may fall foul of antitrust concerns.
The auction is being run out of New York with Morgan Stanley and Centerview Partners advising Pfizer. First-round bids were placed in late 2011 just before Christmas.
All parties involved have declined to comment.