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UPDATE 3-China's top auto firm strikes deal with Toyota

(recasts adding company quotes, analyst comment, details)

By Tiffany Wu

SHANGHAI, Aug 29 (Reuters) - China's largest auto maker, FAW, cemented a partnership with Japan's Toyota Motor Corp on Thursday by agreeing to produce jointly up to 400,000 cars a year by 2010 and take a controlling stake in Toyota's current Chinese partner.

The pact to make a broad range of cars -- from luxury sedans to compacts to sport-utility vehicles -- aims to win a 10 percent share of the rapidly growing but intensely competitive China market by 2010, First Automotive Works (FAW) said.

The deal's "success will not only infuse fresh blood into FAW's goal of realising production of one million cars, but will also help broaden Toyota's space for strategic development," FAW president Zhu Yanfeng told a news conference in Beijing.

"This is the step on the road of strategic cooperation that Toyota has been seeking since entering China. It is also a step for FAW as it quickly melds with the world economy," Zhu said.

FAW plans to buy 50.98 percent of compact car maker Tianjin Automotive Xiali Co Ltd in a deal worth 1.42 billion yuan ($171.6 million), Xiali said separately on Thursday.

The landmark merger will be the biggest in the Chinese auto industry so far and allows FAW to build on Xiali's existing 50-50 venture with Toyota that will start making mid-range cars in October with an annual capacity of 30,000 units.

"One of the attractions for FAW in investing in Tianjin Xiali is its partnership with Toyota," said analyst Angela Gu of Automotive Resources Asia.

"Toyota is the world's third largest auto company and its brand recognition in China is very good," she said.

But the news had little effect on share prices on Thursday, since it was long expected and was not likely to give an immediate boost to profits, analysts said.

Toyota's shares were down 2.84 percent at 2,910 yen at 0645 GMT versus the Nikkei average's 1.50 percent fall. FAW's listed unit outperformed slightly with a 0.95 percent rise to 6.36 yuan, while Xiali was down 0.31 percent.

THE RACE IS ON

FAW and Toyota officials said they planned to roll out 300,000 to 400,000 vehicles in China by 2010, but said the investment and details of car models had yet to be decided.

Toyota, like many Japanese auto firms, wants a greater slice of the potentially massive China market with 1.3 billion people but a very low penetration rate of a 1.5 cars per 1,000 people.

Japan's largest car maker is a relative latecomer to China and -- unlike market leaders Volkswagen and General Motors which have tied up with two of three Chinese auto giants -- its first Tianjin partner is second tier.

"Right now the race is on for everybody to establish positions in this market as it develops, because if you want to be a major volume player when this market matures, now is the time," said Christopher Richter, auto analyst at HSBC Securities in Tokyo. "Once the market matures, it's too late."

FAW already has a flagship car plant with Germany's Volkswagen, but has been seeking another foreign partner to expand in a market that has become hotly competitive since China joined the World Trade Organisation, analysts said.

China has promised to lower tariffs on car imports gradually and let in more foreign cars by increasing import quotas.

FAW's main rival, Shanghai Automotive Industry (Group) Corp, has ventures with both Volkswagen and GM, so FAW had been hoping to catch up, analysts said.

Xiali has also seen its share of the compact car market fall in the past two years as the technology it uses ages and competitors roll out new and cheaper models. The Shenzhen-listed firm reported a net loss for 2001 and the first half of 2002.

It now has a 10.64 percent share of the car market and hopes to ride on FAW's financial strength and wide sales network.

"Although Xiali's market share is shrinking, it is still a significant player and attractive to FAW because FAW does not have its own compact car line," said Gu.

"First-time buyers like small cars, so the segment has a lot of potential and FAW needs to be in this market if it wants to compete across the board in China."

Analysts estimate car sales in China will surge nearly 40 percent to one million this year, which would make the market one of the fastest growing in the world. (With additional reporting by Scott Hillis in Beijing and Daniel Hauck in Toyko) ($1 = 8.276 yuan)