* AkzoNobel says business lacked scale to compete
* To use $875 mln cash proceeds to cut debt, invest
* PPG steps up its challenge to U.S. No.1 Sherwin-Williams
* AkzoNobel shares climb over 6 pct (Adds details, valuations)
By Sara Webb and Gilbert Kreijger
AMSTERDAM, Dec 14 Dutch chemicals group AkzoNobel is selling its struggling North American decorative paints arm to U.S. rival PPG Industries for $1.1 billion to focus on its larger European and faster-growing businesses.
The sale is the latest move by the world's biggest paints maker to address problems it inherited through its 8.1-billion-pound ($13 billion) acquisition of Britain's Imperial Chemical Industries (ICI) in 2008.
The deal will strengthen PPG's challenge to Sherwin-Williams , which has about 36 percent of the U.S. decorative paints market compared with PPG on around 15 percent and AkzoNobel on about 13 percent, according to analysts.
AkzoNobel's North American business, which sells the Glidden paint brand in the United States through retail chains including Wal-Mart Stores and Home Depot, has long been a drag on performance because it lacked the scale to compete with Sherwin-Williams and only recently became profitable.
Shares in AkzoNobel, which in October announced a 2.5-billion-euro ($3.3 billion) writedown on its purchase of ICI due to a weak global economy, surged more than 6 percent on Friday, the biggest rise by a European blue-chip stock.
"In our view, AkzoNobel took full advantage of an improving U.S. housing market, in combination with a delivering restructuring program, to divest a business which would have never been a very strong business for AkzoNobel," Rabobank analysts said in a research note.
However, ING analyst Fabian Smeets was disappointed by the price, which he said equated to 0.7 times enterprise value-to-sales, below other deals in the sector at around 1 times.
"In our view AkzoNobel has sold a significant part of its longer term upside for a relatively low price," he said.
Charles E. Bunch, PPG chairman and chief executive, said the acquisition would "significantly increase our scale in the North American architectural paint market, which we anticipate will benefit from a prolonged construction market recovery."
U.S. housing starts rose to their highest rate in more than four years in October, suggesting the housing market recovery was gaining steam.
AkzoNobel chief executive Ton Buechner, who returned to work from medical leave a week ago, said the Dutch group decided to sell the business because it would have required too big an investment and too much time to make it a significant player.
AkzoNobel, best known in Europe for its Dulux paint brand, said it would receive cash proceeds of about $875 million and would use them to pay down debt and fund growth elsewhere, likely to include China, Latin America and the Middle East.
Buechner plans to update investors on his strategy for the group on Feb. 20 alongside fourth-quarter results.
Last year, AkzoNobel's North American decorative paints unit had revenue of $1.5 billion, about 7 percent of the group total.
The business was loss-making for several years, partly because of under-investment. AkzoNobel shut some company-owned stores to focus more on selling products in Wal-Mart and Home Depot, which are direct competitors, putting pressure on prices.
Its weak performance in the United States is one reason why the Dutch company's shares trade at a lower valuation to U.S. peers, at around 13 times forecast earnings compared with 19.1 for Sherwin-Williams and 16.2 for PPG, according to analysts.
AkzoNobel will still have a strong presence in North America in its other business areas - in performance coatings such as those used for cars, aircraft and ships, and specialty chemicals such as those used in the pulp and paper industry - with revenues of over $2.7 billion and close to 5,000 employees.
The sale was announced just days after Buechner, 47, returned to work after suffering from exhaustion. He said the deal came together in the third quarter while he was on leave.
AkzoNobel plunged to a 2.4 billion euro loss in the third quarter due to the writedown on ICI. Austerity measures in much of Europe and rising raw material costs - especially for titanium dioxide, a paint pigment - have also hit the group.
It warned at the third-quarter results it was looking for more cost cuts on top of the 500 million euros announced last year to cope with weak consumer and construction markets.
($1 = 0.6198 pound = 0.7641 euro) (Reporting by Gilbert Kreijger and Sara Webb; Editing by Helen Massy-Beresford and Mark Potter)