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UPDATE 2-BSkyB in talks to unite Murdoch's pay-TV businesses in Europe

(Adds further details, analyst reaction)

LONDON/FRANKFURT, May 12 (Reuters) - Britain's largest pay-TV company BSkyB is in talks to buy Sky Deutschland and Sky Italia, a 10 billion euro deal that would realise Rupert Murdoch's long-held ambition to combine his European TV interests in a single business.

The potential tie-up would create a broadcaster with 20 million subscribers and more clout to deal with growing competition from rivals such as BT in sport as well as online groups like Netflix in movies and blockbuster TV shows.

In 2010, Murdoch had already tried to take full control of BSkyB, the jewel in the crown of his European operations, but the bid was thwarted by repercussions of a phone hacking scandal involving his British tabloid News of the World in 2011.

Murdoch, whose 21st Century Fox is BSkyB's biggest shareholder, has looked at various options over the years to consolidate his TV holdings in Europe.

The latest proposal would see BSkyB, 39 percent owned by 21st Century Fox, buy Sky Italia and Sky Deutschland, which are 100 percent and about 55 percent owned by Fox, respectively.

British regulators would likely want to examine any deal that would result in Murdoch increasing his overall stake in BSkyB. A source close to the talks said the current thinking was that Murdoch would not raise his stake in BSkyB above 39 percent.

BSkyB said talks were still preliminary and no agreement had been reached on terms, value or transaction structure.

"BSkyB believes at the right value, this combination would have the potential to create a world-class multinational pay TV group," the group said in a statement on Monday.

21st Century Fox said the combination of the Sky-branded European satellite platforms in Britain, Germany and Italy had often been discussed internally.

"From time to time these conversations have included BSkyB, however no agreement between the parties has ever been reached," it said.

BSkyB also said it was not prepared to overpay for Sky Deutschland, noting that any potential agreement would be subject to the Sky Deutschland share price "continuing to trade on an undisturbed basis."

Media reports have put the size of the deal at about 10 billion euros ($13.8 billion).

Shares in Sky Deutschland were up 6.7 percent at 6.76 euros, valuing the group at nearly 6 billion euros ($8.2 billion). Shares in BSkyB were down 2.6 percent by 1118 GMT, giving it a market capitalisation of 13.6 billion pounds ($22.9 billion).

BIGGER SCALE

The tie-up would put the group at the front of the pack if sports rights, which are sold country by country, were in future available on a pan-European basis.

The combined company would have 57 percent of its subscribers in Britain, 19 percent in Germany and 24 percent in Italy, analysts at Citi said. Britain would contribute 68 percent of revenue and 89 percent of group operating profit.

Analysts at Investec said such a deal looked sensible in terms of scale but Italia/Deutschland were in weaker competitive positions, with lower margins and returns, versus Sky.

They said there were economies (of scale) in terms of pan-European deals, such as England's Premier League soccer if it were sold on that basis eventually. A tie-up could protect the group in future against smaller regional competitors like BT and larger online rivals.

"(But) we question major cross-border TV synergies and note lower returns in Italy and Germany and weak competitive positions," they said.

Barriers to a deal include the fact that fact that Sky Italia is yet to renew the Serie A soccer rights in Italy, which is a key part of its TV offering.

Swiss-based agency Infront is preparing a tender to sell television rights on Italy's Serie A soccer matches in the next three seasons. The tender should be ready by Friday, two industry sources said.

When Murdoch tried to take full ownership of BSkyB in 2010, fallout from the phone hacking scandal resulted in British media watchdog Ofcom examining whether News Corp, as it was then called, was a suitable owner of a media company.

With two of his former editors, Rebekah Brooks and Andy Coulson, on trial for phone hacking, the scandal has not faded from the headlines in Britain. They both deny the charges.

News Corp later split into two, with its media assets listed as 21st Century Fox and its publishing activities remaining in News Corp.

($1 = 0.7269 Euros) ($1 = 0.5938 British Pounds)

(Additional reporting by Danilo Masoni in Milan; Editing by Jonathan Gould and Jane Merriman)