UPDATE 5-Russia's Rosneft beefs up with TNK-BP purchase

* BP's Rosneft stake will rise to 19.75 percent with 2 board seats

* Deal extricates BP from thorny partnership, gets closer to Sechin

* Transaction would yield BP $12.3 bln of cash

* AAR deal worth $28 bln but still subject to negotiations

* Two deals independent of each other; BP shares off recent highs

By Darya Korsunskaya and Andrew Callus

MOSCOW/LONDON, Oct 22 (Reuters) - Rosneft tightened its grip on Russia's oil industry on Monday with a $55 billion deal to buy TNK-BP that also makes Britain's BP a one-fifth shareholder in the state-controlled company.

Rosneft, already the top oil company in the world's biggest producing country, will be pumping more oil and gas than Exxon Mobil with TNK-BP under its wing.

With BP's as a partner with two seats on Rosneft's board, powerful chief executive Igor Sechin can also pursue his dream of rivalling the U.S.-based industry number one on the world stage.

The acquisition, subject to Russian government approvals, will give Rosneft extra output and cash flow to finance exploration of Russia's vast reserves to replace ageing and depleting fields.

It keeps BP's technical expertise and international clout in Russia and provides the "quality" private shareholder President Vladimir Putin needs to show critics he is pursuing privatisation and modernisation.

"This is a very good signal for the Russian market. It is a good, large deal. I would like to thank you for this work," Putin told Sechin at a meeting on Monday.

Part one of the Kremlin-backed deal folds BP's half of TNK-BP, Russia's third-largest oil firm, into Rosneft. In exchange, BP gets $12.3 billion of cash and 18.5 percent of Rosneft, raising its holding to 19.75 percent.

In stage two, BP's 50-50 partner in the TNK-BP venture, AAR, would get $28 billion, but the two deals are independent of each other. It leaves the businessmen behind AAR with weakened negotiating power and Rosneft firmly in the driving seat, analysts said.

But the jury is out as to whether Putin will get the effective national champion he wants.

"TNK-BP has been an industry leader in terms of return-on-capital-invested and dividends and as a result was consistently the leader in terms of shareholder capital creation," said Steven Dashevsky, founder and chief investment officer at hedge fund Dashevsky & Partners.

"Rosneft has been the laggard and after the excitement of creation of the juggernaut...after it wears out...the long term question investors have to ask is will this acquisition of a leader by a laggard work?"

The main benefit for BP is an exit from a stormy relationship with AAR, and the chance for closer ties with a Kremlin that exerts a much tighter hold on the oil industry than it did in the 1990s when BP first invested in Russia.

FRICTION

TNK-BP is highly profitable and provides a quarter of BP's total production, but its fields are mature, and the Soviet-born tycoons who own the other half through AAR have blocked BP's search for growth in Russia through closer ties with Rosneft.

Executives at TNK-BP have had run-ins with Russian law enforcement at times of friction between the shareholders, with two managers arrested in 2008 amid a dispute over strategy that forced then-CEO Bob Dudley, who now heads BP, to flee Russia.

Should the deal survive a months-long approval process, BP's exposure to Russia would be lower, but with seats on the board it has closer ties than any of its rivals to Sechin, who has a significant say in energy policy.

BP missed out last year on a deal to go into the Russian Arctic as a result of its feud with the AAR tycoons. It watched as Exxon, ENI and Statoil did deals there.

The cash also gives BP more headroom to give something back to long-suffering shareholders, although analysts have said this may have to wait until BP's other main headache, U.S. Gulf oil spill litigation, is settled.

"They're taking over $12 billion of cash back onto the balance sheet, that'll reduce their gearing from mid-20s down to mid-teens so it transforms the balance sheet," said Investec analyst Stuart Joyner "and the potential in the Arctic that they will access through Rosneft is quite high as well."

The deal is also likely to renew speculation BP will become a takeover target with one of its troubles out of the way and cash in the bank.

"This is an important day for BP," Dudley, under severe pressure from shareholders to show some progress after a difficult few years for his company, told BP staff in a note.

He stressed that agreement remains subject to more detailed agreements being signed as well as to government and regulatory approvals.

"We are making good progress towards these agreements, with a reasonable expectation that they will be concluded sometime during the first half of 2013," he said.

A BP spokesman said shareholder backing is not required, because although the deal is a large one, the assets amount to less than 25 percent of the business according to a number of key measures under UK listing rules.

BP shares climbed four percent last week as preliminary details of the deal emerged. On Monday they fell 1.5 percent to 443.5 pence, slightly underperforming the broader market.

The four tycoons who own AAR, Mikhail Fridman, German Khan, Viktor Vekselberg and Len Blavatnik, are reluctant to remain in a joint venture with the powerful Russian state oil company, even though Khan is effectively serving as chief executive of TNK-BP since the departure of other senior executives.

Their ambitions to expand TNK-BP outside Russia were among the sticking points with BP, and absorption by Rosneft with its own plans to go international puts an end to those dreams.

VALUE TO BP?

Adding the $12.3 billion cash to the stock based on the price BP is paying for a portion of it, BP is getting a package worth $27 billion including an 18.5 percent stake to add to its existing 1.25 percent holding.

However, BP is paying a premium for the stock part, so the value could be calculated lower, at nearer to $25 billion, and lower still when taking into consideration the supportive impact of recent share buybacks by Rosneft.

Either way, although seen as positive by analysts, BP loses a dividend stream that has been providing it with about $4 billion a year.

Based on its new shareholding in Rosneft and that company's 25 percent dividend payout, BP would have only received around half a billion dollars last year.

Some observers are hopeful this may change.

"BP's influence may improve corporate governance standards at the firm and ultimately reduce the corporate governance discount when it comes to the stock market valuation of the company," said Dr Andrey Golubov, a finance lecturer at Cass Business School.

"BP's presence may also mean that the combined firm will have to start paying out more in dividends - again a positive development for minority shareholders."

Neil Shah, global head of research at Edison Investment Research, called the deal "game changing" for BP.

"BP will be left with a well of cash which should create a buffer for the costs from Deepwater Horizon (oil spill rig) and possibly fund future acquisitions," he said.

"We would like to see BP move from retrenchment to expansion, it would demonstrate confidence is returning, it is an oil super-major but only about the fifth biggest in the world and consolidation in the oil sector is far from over."