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Wuhan Iron and Steel Corp., China's fifth-largest steelmaker, has agreed to pay more than 3 billion yuan ($396.4 million) for a 48.41 percent stake in the flagship subsidiary of smaller rival Kunming Iron and Steel Group.

Wuhan Steel will buy the stake in Kunming Steel's main subsidiary for cash by participating in a share capital expansion, a Wuhan Steel spokesman said on Thursday.

Kunming Steel would become the second-largest shareholder, with a 47.11 percent stake, he said.

"We will pay more than 3 billion yuan for the stake," the spokesman said, noting that the specific amount of the payment would be set during the assets transfer.

The tie-up between Wuhan Steel and Kunming Steel would create the country's third-largest steel maker according to 2006 output figures, after Baosteel and Tangshan Iron and Steel Group.

Beijing is encouraging its steel makers to merge while shutting outdated capacity, in order to create a handful of globally competitive giants from the nation's fragmented steel industry.

Anshan Iron and Steel Group, which ranked third by output last year, is merging with smaller rival Benxi Iron and Steel Group.

Wuhan Steel produced 13.76 million tonnes of crude steel last year but has lost its traditional title as China's third-largest mill, as other mills have merged or expanded.

Wuhan Steel will benefit from Kunming Steel's iron ore and coal resources, analysts said. Kunming Steel, the largest mill in the southwestern province of Yunnan, produced 4.8 million tonnes of crude steel in 2006.

The Kunming Steel subsidiary has been planning a Hong Kong listing. It was not immediately clear whether the plan would be affected by the acquisition.