* Agreed deal at 403.5 pence per share
* Widens offering of chemicals for flat-panel displays
* AZ's board recommends bid
* AZ shares up 51 percent
By Ludwig Burger and Paul Sandle
FRANKFURT/LONDON, Dec 5 (Reuters) - Merck, the world's largest maker of liquid crystals used in TVs, tablet and smartphone screens, has agreed to buy Britain's AZ Electronic Materials for $2.6 billion to expand its range of specialist chemicals for hi-tech gadgets.
Germany's family controlled Merck, which also makes cancer drugs and laboratory equipment, will pay 403.5 pence per share in cash for the supplier of chemicals used in Apple's iPad, a 41 percent premium to AZ's three-month average share price.
While many of Merck's peers in the pharmaceuticals industry are selling assets to focus on core businesses, Merck's deal underscores its position as a diversified group, with the family behind it seeking to spread its investment risk.
"Our philosophy has always been to never put all eggs in one basket," finance chief Matthias Zachert told reporters on Thursday.
The electronics industry uses specialty chemicals to produce chips, displays and other components. Many of the products are high-margin, but demand is closely tied to production cycles in manufacturing centres like Taiwan.
Analysts said AZ's optronics business, which supplies products to make flat panels, complemented Merck's display business. They share customers such as Samsung, Sony , Panasonic and Innolux Corp.
Zachert said the deal would also give Merck new customers, such as semiconductor maker SK Hynix Inc.
Optronics made up 32 percents of AZ's $363.7 million revenue in the six months to end-June. Supplies of chemicals to the chip-making industry accounted for the rest.
Shares in the British group, which joined the stock market in 2010 at 240 pence, were up 51 percent to 398 pence at 1127 GMT. Shares in Merck were up 3.3 percent.
BOTTOM OF CYCLE
Liberum Capital analysts said the price looked fair, with an 2014 enterprise value to core earnings multiple of 11.1 times in line with the 9-12 times range typical for previous specialty chemicals deals.
"While a counter bid cannot be ruled out the offer price seems fair and the significant premium may deter others from bidding," they said.
Shares in AZ reached a high of 411.6 pence in March 2013 before a profit warning the following month, on weak demand from chipmakers, wiped a quarter of the value off its share price.
Analysts at Espirito Santo said Merck was buying a high- quality company at the bottom of the cycle, noting AZ was well positioned for an upturn in the production of the wafers used to make chips.
While the price meant the possibility of a counter bid was low, they said, other specialty materials companies such as Air Products, Air Liquide and Linde might be interested.
Buying AZ, which was originally part of German chemical company Hoechst AG, would add 5 percent to Merck's sales and 7 percent to core earnings based on 2012 numbers, DZ Bank analyst Peter Spengler said.
AZ's board of directors are recommending shareholders accept the offer. The directors have committed themselves to tender their own shares, representing approximately 0.7 percent of the total.
Merck will fund the deal, plus about 240 million euros of debt, from existing cash reserves. It is conditional on the backing of 95 percent of AZ's shareholders.
BoA Merrill Lynch advised Merck, while Rothschild, Goldman Sachs and UBS advised AZ.