UPDATE 3-Spain's Mapfre to buy Direct Line's German, Italian units for $700 mln

(Corrects second last paragraph to say Direct Line went public in 2012, not last year)

* Spain's Mapfre (Other OTC: MPFRF - news) to fund acquisition with own cash

* Direct Line shareholders to receive proceeds from sale

* Deal part of Mapfre global expansion plan

By Karen Rebelo and Robert Hetz

MADRID, Sept 25 (Reuters) - Spanish insurance company Mapfre is to buy the Italian and German businesses of Direct Line, Britain's largest motor insurer, for 550 million euros ($700 million), in a deal that will immediately boost earnings, Mapfre said on Thursday.

"The Italian and German assets acquired are absolutely strategic for Mapfre, strengthening the two main lines of our global growth plan, allowing us to increase our presence in Europe," Chairman Antonio Huertas said in a statement.

Mapfre, which said it would fund the operation with its own cash, operates in 47 countries with over 23 million clients worldwide and is one of the top 10 largest insurance groups in Europe in terms of premium volumes.

Direct Line was in advanced talks with four suitors to sell the businesses, Huertas said in a conference on the sale, confirming a report by Reuters.

Industry sources said Direct Line's Italian business was the main attractiion for bidders, who included Germany's Allianz and France's Axa (Paris: FR0000120628 - news) in the final stage of the sale process.

In Germany Direct Line is the third-biggest player in the online car insurance market, with about 600,000 customers, behind mutual insurer HUK24 and DA Direct, which is part of Zurich Insurance (Xetra: ZFI1.DE - news) .

Direct Line's Italian and German businesses come with insurance premiums worth 714 million euros and 1.6 million clients and would have been worth 19.5 million euros in pre-tax profits in 2013, Mapfre said.

SALE DIVIDEND FOR DIRECT LINE SHAREHOLDERS

All net proceeds from the sale would be returned to Direct Line's shareholders, the British company said, adding that it expects to recognise a pre-tax gain of about 160 million pounds ($260 million) from the sale.

Direct Line shareholders should expect up to 26 pence per share in a special dividend once the deal has been finalised, according to Deutsche Bank (Xetra: 514000 - news) analyst Oliver Steel.

Direct Line's share price was up 0.67 percent at 299.0 pence by 1028 GMT, when Mapfre's was down 0.34 percent at 2.9 euros. The Stoxx Europe 600 European insurance sector index was up 1.69 percent.

"This is a good outcome for shareholders in our view, with the International units strategically challenged and operating in tough markets," Shore Capital analyst Eamonn Flanagan said.

Direct Line, whose brands also include Churchill, Privilege and the Green Flag roadside recovery service, was spun off from Royal Bank of Scotland (LSE: RBS.L - news) in an IPO in 2012.

Deal activity in the insurance sector has risen this year, helped by the stock market listing of Dutch insurer NN Group , Europe's biggest initial public offering (IPO) of 2014. (Additional reporting by Jonathan Gould and Paul Day; Editing by Robert Hetz and Greg Mahlich)