* Applied Materials shareholders to hold 68 pct of company
* Applied CEO to lead new company
* Applied shares rise 9 pct, Tokyo Electron jumps 13 pct
By Reiji Murai and Supantha Mukherjee
Sept 25 (Reuters) - Applied Materials Inc agreed to buy rival Tokyo Electron Ltd in an all-stock deal worth more than $10 billion, combining the No.1 and No.3 makers of chip-making gear as demand for their products slows and it gets tougher to turn a profit.
The deal, which analysts expect to hold up under scrutiny from antitrust regulators, aims to create a new company with a shared leadership team that is 68 percent owned by Applied Materials shareholders, the companies said on Tuesday.
The value of the deal is worth $10.16 billion, based on Tokyo Electron's issued shares, Applied Materials' latest stock price, and the agreed upon stock ratio, making it the second-largest acquisition by a foreign buyer in Japan, according to Thomson Reuters data.
Applied Materials shares finished 9 percent higher on the Nasdaq on Tuesday at $17.45. Tokyo Electron's shares surged 13.2 percent on Wednesday to 5,490 yen.
Applied, Tokyo Electron and Dutch chip equipment maker ASML Holding NV are the three largest players in an industry that has consolidated as the rising cost of developing cutting-edge chips and slowing semiconductor demand forced alliances and acquisitions.
The combined market value of Applied and Tokyo Electron at the time of the announcement was around $29 billion.
Most U.S. chipmakers have sold off or mothballed capacity and outsourced manufacturing to Asian foundries such as Taiwan Semiconductor Manufacturing Co Ltd, further eroding Applied's customer base.
The American company's net income has fallen steadily over the past two years and it posted losses in two quarters during that period. Tokyo Electron reported a 23 percent drop in quarterly sales in July.
ASML bought U.S.-based Cymer last year for about $2.5 billion, while Lam Research Corp bought smaller rival Novellus Systems Inc for $3.3 billion.
"When you look at the buyers of semiconductor equipment; when you look at the people who are really making very advanced chips these days, it's a very small number," Mike Splinter, Applied Materials' executive chairman, told Reuters. "Technology changes are getting more difficult and complex."
Despite their global reach and scale, few of their products overlap, analysts said.
RBC analyst Mahesh Sanganeria said both companies sell etching equipment, used to carve circuits onto silicon, but Applied Materials is a relatively small player in that market compared with rival Lam Research.
"There isn't that much overlap at the product level. I think it will be looked at closely, but I think it will go through," Sanganeria added.
Close competitors of the new company would include Lam Research, KLA-Tencor Corp and Hitachi Ltd subsidiaries Hitachi High-Technologies Corp and Hitachi Kokusai Electric Inc.
"We've looked at this in a lot of detail and we think the overlaps are very, very small," Splinter said.
Citigroup paid $12.56 billion in two tranches for Japanese bank Nikko Cordial in 2007, which remains the largest ever foreign acquisition in the country, Thomson Reuters data shows.
Should the acquisition win the OK of regulators, the combined company might be able to ride the next big wave of capital investment from chipmakers.
Intel Corp, Samsung Electronics Co Ltd and TSMC are planning a new generation of mega-factories - a major shift that will require tens of billions of dollars. Within a decade, there could be just a handful of plants around the world producing the most cutting-edge microchips.
"Applied Materials is going to be the biggest beneficiary from this deal, given that they're going to be a large company and I think their customer exposure also improves following this deal," Stifel Nicolaus & Co analyst Patrick Ho said.
The deal is the biggest ever for Applied Materials, whose last big acquisition was Varian Semiconductor Equipment Associates for $4.9 billion in 2011. The companies expect the deal to close in the middle to the second half of next year.
For every existing share, Tokyo Electron shareholders will receive 3.25 shares of the as-yet unnamed new company and Applied Materials shareholders will receive 1 share.
Applied Materials CEO Gary Dickerson will be chief executive of the new company and Tokyo Electron Chief Executive Tetsuro Higashi will become chairman. The companies will maintain dual listings on Nasdaq and the Tokyo Stock Exchange.
Dickerson told analysts he would move to Japan to lead a company whose board will comprise 11 directors - five appointed by each company and another they both agree upon.
The companies said they expected to achieve $250 million of savings by the end of the first fiscal year of operation. The new company will also buy back $3 billion of its shares within 12 months of the combination, they said.
Goldman, Sachs and Co acted as Applied Materials' financial adviser, while Tokyo Electron was advised by Mitsubishi UFJ Morgan Stanley Securities Co.
Jones Day and Nishimura & Asahi represented Tokyo Electron. Weil, Gotshal & Manges LLP, Mori Hamada & Matsumoto, and De Brauw Blackstone Westbroek advised Applied Materials.
"They have the highest profit margins, they have the best balance sheets, they make money through thick and thin," said David Rubenstein, senior analyst at Advanced Research Japan. "So they are not desperate, but they are hungry for earnings growth and this is one way they can do it."