Watson Pharmaceuticals Inc is close to buying Swiss-based Actavis for around $7 billion, marking the latest deal between generics companies racing to achieve economies of scale, three sources familiar with the matter said.

The deal would involve U.S.-based Watson, already among the world's five largest generic drugmakers, paying between 5.0 billion and 5.5 billion euros ($6.6-7.3 billion) for Actavis, a business not much smaller than its own, the sources said.

After rapid expansion in the early 2000s, Actavis underwent a leveraged buyout in 2007 by Icelandic tycoon Bjorgolfur Thor Bjorgolfsson, which ultimately left Deutsche Bank holding billions of euros of its debt.

It has since been seen as a target for either an eventual initial public offering or a trade sale. Its strong presence in central and eastern Europe fits with Watson's desire to expand in these particular emerging markets.

Spokesmen at Watson, Actavis and Deutsche Bank declined to comment on Wednesday.

Targeting Actavis is a bold move for Watson, whose previous acquisitions include the $1.75 billion purchase of Arrow Group in 2009, which established a foothold for the company in Europe, and the $1.9 billion purchase of Andrx Corp in 2006.

The purchase of Actavis would be far larger but could be made to work since there would be scope for significant synergies, including the possible closure of some manufacturing capacity in the United States.

The generics sector has seen a wave of M&A in recent years because Western governments are putting pressure on the industry to provide drugs at the lowest possible price, which favors large players who can produce at low costs.

Watson further expanded its European presence last year when it bought Greece-based Specifar Pharmaceuticals for $562 million.

EARNINGS BOOST

One source said synergies in year two from buying Actavis could reach around 200 million euros, assuming the closure of the Swiss firm's plant in Elizabeth, New Jersey, and rationalization of global drug development portfolios.

Watson has a reputation for making acquisitions work and shares in the company rose 6 percent following the Reuters report, as investors anticipated a deal that would boost earnings.

Morningstar analyst Michael Waterhouse said Watson has lacked the international presence of larger rivals Teva Pharmaceutical Industries Ltd , the Sandoz generics unit of Novartis AG , and Mylan Inc .

If Watson wants to be competitive with those bigger players, it's probably a move in the right direction, Waterhouse said.

Gabelli & Co analyst Kevin Kedra noted Watson had talked about a transformational deal and buying Actavis would fit the bill.

It's a consolidating industry and it's an industry that is basically winding down to just a few Goliaths and most of the Davids are getting scooped up, Kedra said.

Watson already enjoys a good working knowledge of Actavis - which used to be based in Iceland but moved its headquarters to Zug, Switzerland in 2011 - since a former chief executive of the group now works for the U.S. company.

Sigurdur Oli Olafsson joined Watson as head of global generics in September 2010, with responsibility for expanding sales and marketing outside the United States. Many analysts have been expecting the U.S. company to strike more deals, since it has more flexibility to take on debt than rivals Mylan and Teva.

Watson Chief Executive Officer Paul Bisaro said last month he was interested in acquisitions that would boost its generics business or its branded-drugs business, which focuses on women's health and urology.

Asked on the company's earnings conference call about indications he was eyeing a big branded acquisition, he said: I've also made it very clear that if the right generic-focused large transaction presented itself, it would help us expand our footprint globally and drive additional growth through our generics business, we would do that one as well.

DEUTSCHE BANK EXIT

Watson, with a market capitalization of around $7.5 billion, had sales last year of $4.6 billion. Revenue was fuelled in the last quarter by generic versions of Pfizer Inc's

Lipitor cholesterol treatment.

Meanwhile, Actavis CEO Claudio Albrecht told Reuters at the end of last year that his company's sales were expected to hit 2.1 billion euros in 2012, up from 1.75 billion in 2010.

Chris Schott, an analyst at J.P. Morgan, said he saw few antitrust hurdles to completing the deal as the companies' European businesses have little overlap, and overlap with the U.S. businesses appeared manageable.

Schott added that Watson might be able to improve its tax rate through a merger with Actavis, given its Swiss location.

Watson ranked as the world's fifth-biggest generic drugmaker by sales, while Actavis stood at 15th, according to recent data from IMS Health. Watson would move up to fourth, ahead of Sanofi SA , with Actavis in the fold.

The sale of Actavis would mark the end of a tricky episode for Deutsche Bank, which took an impairment charge of 407 million euros on its stake in the company in the fourth quarter of 2011.

The German bank has total senior debt in Actavis of around 3.5 billion euros, according to two sources, alongside smaller debt holdings by Icelandic banks and others.

(Additional reporting by Philipp Halstrick in Frankfurt and Lewis Krauskopf in New York; Editing by Hans-Juergen Peters)