Carillion in talks with Balfour Beatty on 3 bln pound merger

* Carillion (LSE: CLLN.L - news) and Balfour shares jump

* Biggest gainers on FTSE 250 index

* Potential merger worth 3 billion pounds (Recasts)

By Li-mei Hoang

LONDON, July 25 (Reuters) - British construction company Carillion is in talks with Balfour Beatty (Other OTC: BAFBF - news) on a possible merger that would create a 3 billion pound ($5.1 billion) group with the muscle to compete with rivals such as Spain's Ferrovial and France's Vinci (Other OTC: VCISF - news) .

The approach from Carillion follows a difficult 18 months for Balfour Beatty, which has had a series of profit warnings and lost its CEO Andrew McNaughton in May.

Carillion, with a market capitalisation of some 1.5 billion pounds before the talks were revealed, currently operates in Britain and Ireland (Other OTC: IRLD - news) , Middle East and North Africa and Canada.

A deal with Balfour, which operates in more than 80 countries providing construction, engineering and facilities management services, would significantly expand its international business.

Carillion, which maintains British railways, roads and military bases, said in March that it planned to diversify its support services business into sectors such as oil, power distribution and highways maintenance.

Its projects include the redevelopment of London's Battersea Power Station. It has won a string of contracts in the past 18 months worth 10 billion pounds.

This week Carillion won three contracts worth up to 2.8 billion pounds in a joint venture with infrastructure firm Amey to deliver support services to Britain's Ministry of Defence.

Its shares are up 10 percent year to date, not including a rise on Friday of more than 7 percent.

Balfour, which had a slightly larger market value of about 1.6 billion pounds, said in July it would take another 35 million pound hit to its profit after trading in its mechanical and electrical engineering division deteriorated.

Balfour is expected to report a 20 percent fall in annual pretax profits to 150.30 million pounds, according to an average estimate of 13 analysts polled by Thomson Reuters.

Its shares have fallen by 20 percent since the start of the year. They rose more than 9 percent on Friday.

"Balfour Beatty's recent operational performance has been extremely poor. It does not have a chief executive. Its shareholders are frustrated," Liberum analysts said.

"It is far too early to assess terms or levels, but we expect an acquisition of Balfour Beatty would be 20 percent accretive to Carillion," they said.

The companies' combined revenues could be more than 14 billion pounds, with an order book of more than 31 billion pounds, and annual savings of around 200 million pounds, Whitman Howard analyst Stephen Rawlinson said.

"If some trading issues improve and the savings can be achieved, the combined entity would be a candidate for FTSE 100 entry as market capitalisation should get to 4 billion pounds," he said.

Balfour has the higher price to earnings ratio of the two firms, at 12.6 times for Balfour compared with 9.8 for Carillion, according to Thomson Reuters data.

The companies have until Aug. 21 to announce a firm intention to merge or state that a deal will not take place.

(Editing by Kate Holton, Ruth Pitchford and Jane Merriman)