* Paddy Power agrees merger with betting exchange Betfair
* New group poised to be UK market leader online
* Taxes and regulation drive wave of gambling mergers (Adds details, quotes)
By Neil Maidment and Padraic Halpin
DUBLIN/LONDON, Aug 26 (Reuters) - Betfair and Irishrival Paddy Power have agreed in principle on a 5billion pound ($7.85 billion) merger to stake a claim toleadership of the online gambling market in Britain.
Discussions were continuing to finalise an all-share mergerbut key terms have been agreed to create one of the world'slargest online betting and gaming groups with revenue of over1.1 billion pounds, the companies said on Wednesday.
The betting sector has seen a string of deals this year ascompanies respond to higher tax bills in Britain and tighterregulation by looking to bulk up and better compete in an onlinemarket buoyed by the increasing use of mobiles and tablets.
"We fundamentally believe this industry is all about scale,"said Betfair Chief Executive and ex-Paddy Power Chief OperatingOfficer Breon Corcoran, who would lead the new group.
"By putting together two distinct but phenomenally strongbrands, we'll have a market leading position in the UK, Ireland,Australia and in the United States," he told Reuters.
Shares in Paddy Power and Betfair were up 18 percent and 17percent respectively on the news.
Under the terms, Paddy Power shareholders would own 52percent of the group with Betfair investors owning the rest.Immediately prior to completion, Paddy Power shareholders wouldreceive a special dividend of 80 million euros ($91.9 million).
The new group would be the market leader online in the UKwith a share of 16 percent, according to industry data, passinga merged Ladbrokes Coral group on 14 percent, as well as William Hill and privately owned Bet365.
Paddy Power Chairman Gary McGann would keep his role in thecombined group, while its CEO Andy McCue would become COO.Betfair finance chief Alex Gersh would also stay put.
GAMBLING ON MERGERS
The gambling sector is seeing a wave of mergers.
Last month bookmakers Ladbrokes and Gala Coralstruck an all-share deal, creating a 2.3 billion pound bettinggroup. 888 and GVC Holdings are locked in abidding war for online gambling firm Bwin.party DigitalEntertainment.
Under the proposed merger, Corcoran said both brands willoperate side by side in Europe. Paddy Power's portfolio ofalmost 600 betting shops, more than half of which are inBritain, will also remain part of the plans.
Betfair is an exclusively online business, best known forits technology which allows gamblers to bet against each other.Alongside its core exchange product, the firm is also targetinga larger share of the broader sports betting market.
Analysts pointed to significant scope to cut costs throughthe removal of duplication within the two businesses.
Davy Stockbrokers declared "the two best quality companiesin the European online gaming sector are on the verge ofmerging".
Paddy Power is the larger of the two with a marketcapitalisation of 3.46 billion euros ($4 billion) at Tuesday'sclose, versus 2.43 billion pounds ($3.81 billion) for Betfair,which has seen its shares rise by 140 percent in a year on theback of strong revenue growth.
Both firms also gave trading updates on Wednesday.
Betfair said core earnings rose 19 percent in the threemonths to July 31, despite higher UK tax charges. Paddy Powersaid first half operating profit had grown by a third to 80million euros against the same regulatory headwinds. ($1 = 0.6369 pounds) ($1 = 0.8707 euros) (Editing by Kate Holton and Keith Weir)
