The takeover, Asia's fourth-largest financial services deal, would make Singapore-based DBS the fifth-biggest lender in Indonesia, one of the region's hottest markets where bank penetration is low and annual loan growth runs at 20 percent.

However, Danamon has lower returns on equity than some of its peers and a heavy exposure to auto financing, an area vulnerable to recently announced policymakers' steps to curb excessive lending in Southeast Asia's largest economy.

"We have the capacity to unshackle these businesses," Chief Executive Piyush Gupta said in Jakarta on Monday, briefing investors and media on his first major deal since taking over as boss of DBS in late 2009.

He said the DBS would use its balance sheet to cut Danamon's funding costs and unleash its potential - and also break DBS' perception as a low-margin, mature-market bank.

"What this deal does for us is changing DBS from being 11 percent in high-growth markets to 33 percent exposure to high-growth markets," Gupta added.

But the price - S$6.2 billion ($4.93 billion) in shares and the rest in cash - surprised some investors. DBS is also buying most of Danamon from Singapore state investor Temasek Holdings TEM.UL, also a major shareholder in DBS.

"They will have to show that their strategy is adding value to shareholders," said Roger Tan, head of SIAS Research, an arm of the Securities Investors Association of Singapore.

Though the offer, worth 7,000 rupiah ($0.77) per Danamon share, looked steep on a premium basis, it looked less generous using another valuation yardstick: at 2.6 times book value, the deal was below some other big banking takeovers in Indonesia.

"The price of the acquisition is quite surprising for us given Danamon now trades at 4,600 (rupiah)," said Jemmy Paul, head of equity fund, Sucorinvest Asset Management.

But he added that it looked fair when viewed as multiples of both Danamon's book value and its earnings, estimating that DBS was paying about 18.4 times the Indonesian bank's profits.

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Graphic on deal: link.reuters.com/tep47s

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ALSO LOOKING TO EXPAND IN MALAYSIA

DBS also signaled on Monday it wanted to expand as well in Malaysia, saying it had received approval to begin talks to buy an effective 14 percent stake in Alliance Financial Group (ALFG.KL) - again from Temasek.

The Alliance stake is worth about $270 million. Shares in the Malaysian bank jumped 3 percent on the news.

Shares in both DBS and Danamon were halted from trade on Monday, pending the announcement. The Indonesian bank's stock has fallen by a quarter over the past 12 months while Indonesia's wider stock market has risen 12 percent.

DBS has fallen about 2 percent in the same period.

CEO Gupta said Danamon suffered from relatively high funding costs because of a weaker deposit base and its reliance on wholesale markets, where interest rates have climbed sharply since the global financial crisis four years ago.

Gupta aims to expand the bank beyond Singapore and Hong Kong, which account for the bulk of its profits.

DBS' track record with acquisitions had been tarnished by its purchase of Hong Kong's Dao Heng Bank more than a decade ago which led to two big writedowns in later years.

Aberdeen Asset Management, which owns DBS shares, said the Danamon move was logical for DBS, though it questioned whether the Indonesian government would have any concerns over the deal.

Indonesia's central bank last year mooted a law to limit bank ownership, putting several deals in the sector on ice, but the country's state deposit agency recently said that policymakers would not implement the regulation.

"It will be interesting to see the reaction of Indonesian authorities," said Hugh Young, head of Aberdeen's Asian operation.

DBS's Gupta said he expected the deal to close in the second half of the year, subject to regulatory approval.

Eight of Indonesia's top 11 banks by market value are either controlled by foreign banks, business families, private equity firms or wealth funds.

DBS said it would initially pay S$6.2 billion in shares to buy a 67.37 percent stake in Danamon from Temasek. It would then buy out Danamon's minority investors for cash.

DBS said it would issue 439 million new shares at S$14.07 each to Fullerton Financial Holdings, the Temasek unit that holds the stake in Danamon. Temasek already owns about 29 percent of DBS and its stake would rise to about 40 percent.

Temasek has obtained a regulatory waiver from having to make a general offer for the remaining DBS shares.

The Danamon deal's implied price-to-book ratio of 2.6 times is below the 4.2 times paid by HSBC (HSBA.L) for Indonesia's Bank Ekomomi Raharaja in 2008. It is also below the multiple paid by Maybank (MBBM.KL) for Bank Indonesia Internasional.

Gupta, 52, has spent a large part of his career in India and Southeast Asia - areas where DBS is keen to grow - but he could be tested in Indonesia where the government recently moved without notice against foreign control of local mines.

Credit Suisse (CSGN.VX) and Morgan Stanley (MS.N) are DBS's joint financial advisers, while WongPartnership LLP and Hadiputranto, Hadinoto & Partners are legal advisers.

Temasek is being advised by Bank of America-Merrill Lynch and UBS (UBSN.VX). Danamon is being advised by Citigroup (C.N) and Deutsche Bank (DBKGn.DE). ($1 = 1.2574 Singapore dollars) ($1 = 9144.0000 Indonesian rupiah)

(Additional reporting by Kevin Lim in SINGAPORE; Editing by John O'Callaghan and Mark Bendeich)

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