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UPDATE 1-Britain's GKN, fighting hostile bid, says in talks over auto unit deal

deal@ (Adds detail, background)

LONDON, March 2 (Reuters) - British engineering company GKN is in talks with Dana Incorporated over its auto unit, opening up a new front in its battle to fight off a hostile 7 billion pound ($9.6 billion) bid from Melrose Industries.

GKN said on Friday that it was talking to U.S.-based car parts maker Dana Incorporated about a combination of GKN Driveline with Dana in a deal to be effected mainly in equity.

Seeking to fight off turnaround specialist Melrose's cash and shares approach which it argues undervalues it, GKN already has a plan to demerge its main aerospace and automotive businesses by the middle of next year.

The talks with Dana came about after it received a number of approaches for its businesses, GKN said.

The potential deal with Dana could provide greater value to shareholders than its demerger plan, GKN said, and it would therefore explore it as an option.

The involvement of U.S. buyer Dana, an Ohio-headquartered maker of axles and driveshafts, could prompt scrutiny from British lawmakers as some politicians have already expressed worries about GKN ending up in foreign hands.

Britain's defence secretary has said he has "serious concerns" about a change of ownership. GKN's defence unit makes components for the Eurofighter Typhoon.

GKN cautioned that the discussions may not lead to any transactions and advised shareholders not to take any action in relation to the Melrose offer.

Melrose shareholders are due to vote at a March 8 meeting on the potential acquisition and the turnaround specialist's plan to issue shares to help to finance the GKN bid.

GKN also on Friday issued a second statement to say it was in talks with its trustees over what a possible demerger of its business would mean for its pension schemes. It had previously warned that Melrose's bid could hit its pension.

It said it would make a 160 million pound contribution to the scheme upon demerger. ($1 = 0.7265 pounds) (Reporting by Sarah Young Editing by Kate Holton and Keith Weir)