Privately owned U.S. orthopedics group Biomet is set to begin informal talks with Smith & Nephew

about a potential 15 billion pounds ($23.6 billion) merger, the Daily Telegraph newspaper said on Friday, without citing sources.

Merging the two groups would block attempts by Johnson & Johnson to acquire the British company, which is Europe's biggest maker of replacement knees and hips.

Shares in Smith & Nephew (S&N) hit a record high of 739 pence on Monday after a report it received a bid last month from Johnson & Johnson, which was not disclosed.

The shares receded after no confirmation of talks from either company, dashing investor hopes of an imminent bid from Johnson & Johnson or anybody else.

The British company has been tipped as a target for some time, although speculation has gained traction in recent weeks after a media report early in December linked Biomet's private equity owners with Smith & Nephew.

The shares were 3.4 percent higher at 708 pence by 5:34 a.m. ET.

Investec analyst Sebastien Jantet, who moved to a hold from buy after the price spiked on Monday and no deal materialized, said a merger with Biomet was less attractive than a potential cash bid.

The positive is it gives them scale in the orthopedics market and there will be some cost savings, although those would be difficult to quantify at this stage, he said.

The bad news for shareholders is you massively increase the gearing levels of the group to take on all of Biomet's debt.

Jantet also said a merger would rule out a takeover from a larger rival on competition grounds, removing the premium from the stock, and it would also focus the group on orthopedics, the slowest-growing part of the business.

Scale is becoming increasingly important in orthopedics as hospitals consolidate suppliers to reduce costs.

Smith & Nephew, which also has woundcare and endoscopy divisions, and Biomet are ranked six and seven in the combined knees, hips and trauma orthopedic market behind J&J, Zimmer

and Stryker, according to Wells Fargo Securities.

Smith & Nephew's Chief Executive David Illingworth said there would be consolidation in the industry.

Customers are going to want to deal with companies that have a thoughtful, broad range of products and services, he said at the J.P. Morgan Healthcare Conference in San Francisco on Monday.

The Biomet deal would see the combined group relist on the London market, with S&N shareholders taking the lion's share of the equity, the Daily Telegraph said.

Because of the levels of debt attached to Biomet, a cash acquisition of S&N would not be possible, creating the need for a complex merger structure. Although no formal offer has been made, both sides have been examining the possible structure on the table, it said.

Officials at S&N were not available to comment on the newspaper report.

(Editing by Hans Peters)