UPDATE 2-China Eastern buys Shanghai Airlines, shrs soar

* Deal valued at 9 billion yuan ($1.3 billion)

* China Eastern to raise about 7 billion yuan via share sale

* New airline to have 50 pct share in Shanghai market (Recasts, adds details, stock movement, analysts' view)

By Samuel Shen and Parvathy Ullatil

SHANGHAI/HONG KONG, July 13 (Reuters) - China Eastern Airlines said it will acquire rival Shanghai Airlines, a 9 billion yuan deal ($1.3 billion) which will create a newly capitalised carrier with more than half the air business in China's financial hub.

Both airlines rose by their 5 percent daily limit in Shanghai on Monday on the share-swap deal. China Eastern's (600115.SS) (0670.HK) Hong Kong-listed shares rose as much as 14.4 percent in early trade to an 11-month high.

Analysts said the initial price euphoria over the deal would subside. Shares for both companies had been suspended since early June pending an announcement on the highly anticipated merger.

"The merger is beneficial in the long term as China Eastern's market share will be greatly enlarged. But in the short-term, money matters continue to be an overhang," said Linus Yip, strategist with First Shanghai Securities.

"The initial stock reaction seems to have captured most of the positive news in the announcement so in the short term investors will do well to sell the stock," he said.

Under their plan, each share of Shanghai Airlines (600591.SS) would be exchanged for 1.3 China Eastern shares, according to a Shanghai Stock Exchange filing. That ratio equates to a premium of about 17 percent to Shanghai Airlines last stock price before the trading suspension.

Shanghai Airlines shares would be delisted after the swap.

The broader plan would also see China Eastern raise about 7 billion yuan by selling up to 1.35 billion new yuan-denominated A-shares to 10 selected institutions for at least 4.75 yuan each; and as many as 490 million H shares to a related company in Hong Kong for at least HK$1.4 each.

That capital raising would follow another 7 billion yuan cash injection from its state-owned parent earlier this month via A- and H-share issues. [ID:nSHA167138]

"These new funds, plus the integration of rival Shanghai Airlines, effectively relaunches the carrier," Merrill Lynch wrote in a research note. "It will dominate the Shanghai market and offers an interesting restructuring play for investors."

The merger between the two loss-making carriers will create an airline that can compete more effectively with domestic rivals Air China (601111.SS) (0753.HK) and China Southern Airlines (600029.SS) (1055.HK).

Merrill Lynch said the deal should help China Eastern's pricing and profits, but added failure to cut headcount and aircraft means the combined entity is "leaving major cost cutting opportunities untouched."