FRANKFURT (Reuters) - Germany's top utility E.ON (>> E.ON SE) said it would split in two, spinning off power plants to focus on renewable energy and power grids, in a dramatic response to industry changes that could trigger similar moves at European peers.

Europe's power sector has been hit by weak energy demand in a sluggish economy, low wholesale power prices and a surge in demand for cleaner renewable energy which is replacing gas and coal-fired power plants.

The move is the boldest by a German company since Chancellor Angela Merkel's 'Energiewende' in 2011, a policy that encouraged cleaner energy and a move away from fossil and nuclear fuels, disrupting business models for utilities.

E.ON, whose market value plunged by near three quarters since 2008, said it would focus on renewables, distribution networks and tailor-made energy efficiency services to embrace changes in energy markets, technology and customer demand.

"We have seen the emergence of a new energy world," Chief Executive Johannes Teyssen said on Monday.

"E.ON's existing broad business model can no longer properly address these new challenges."

E.ON said existing provisions for the dismantling and disposal of nuclear and conventional assets would be fully covered in the new company's balance sheet, adding that unit would have a positive net financial position and an investment grade rating.

All outstanding bonds as well as all debt are to remain with E.ON, which said it was working hard to avoid its credit rating from getting downgraded by more than one notch as a result.

Standard & Poor's is putting E.ON's long-term credit rating at "A-". Moody's sees it at "A3".

E.ON's shares jumped 6.3 percent then settled back a little to be up 4.4 percent by 1542 GMT, the biggest gainer among European utilities <.SX6P>.

EXTREMELY BRAVE

"From an investor perspective, the spin-off would be desirable as it would give E.ON two clear-cut business models that are easier to assess than the conglomerate," said Thomas Deser, senior fund manager at Union Investment, E.ON's seventh-largest shareholder.

E.ON said it would prepare next year for the listing of the new company created by its breakup, with the spin-off taking place in the second half of 2016.

JP Morgan is acting as the sole advisor in the group's spin-off, a source with knowledge of the matter told Reuters.

E.ON said about 40,000 of its employees would remain with the parent group, while the remaining 20,000 would join the new company.

"We see this as an extremely brave but progressive move by E.ON," RBC Capital Markets analyst John Musk wrote in a note to clients, keeping an "outperform" rating on the stock.

"The question now becomes if other integrated utilities will follow suit."

E.ON's new focus on its regulated grids and its renewables business - which is quasi-regulated, as it depends largely on state subsidies - has the potential to boost its valuation.

In the Stoxx European Utilities index, <.SX6P> regulated grid operators like Spain's Red Electrica (>> Red Electrica Corporacion SA), Britain's National Grid (>> National Grid plc), and Italy's power grid Terna (>> Terna - Rete Elettrica Nazionale SpA) and gas grid operator Snam (>> Snam SpA) are among the most highly valued stocks, with price/book ratios ranging between 4.5 and 2.4.

Utilities with large thermal power generation assets such as E.ON, France's GDF Suez (>> GDF SUEZ), Italy's Enel (>> Enel S.p.A.) and Spain's Iberdrola (>> Iberdrola SA) are at the bottom of the valuation ranking, with price/books around or below 1.

In a study last month, Credit Suisse analysts said GDF Suez - whose business is similar to E.ON - suffered a "conglomerate discount" of 5 to 40 percent and suggested GDF could restructure and list its French networks separately.

E.ON's main German peer RWE (>> RWE AG) on Monday said it had no intention of following E.ON's example.

SPIN OFF, WRITE DOWN

E.ON said it would transfer a majority of the new company's capital stock to its shareholders, avoiding the sale of new shares on the open market as is the case during an initial public offering (IPO).

Instead, investors in E.ON will receive shares in the new company in addition to holding shares in the parent company, much in the same way that Bayer (>> Bayer AG) shareholders received shares in speciality chemicals unit Lanxess (>> Lanxess AG).

E.ON, which has 31 billion euros ($38.7 billion) in net debt, said it would dispose of its minority stake in the new company over the medium term to bolster its finances.

Spinning off power generation will rid E.ON of a sector that has been hard hit by Germany's decision to encourage renewables such as wind and solar power with tariffs that discourage the use of gas, coal and nuclear power plants.

E.ON also said it would post a substantial net loss for 2014 due to additional charges of about 4.5 billion euros in the fourth quarter, citing its assets in southern Europe as well as loss-making power plants.

The supervisory board had approved a proposal to pay a dividend of 0.50 euro per share for 2014 and 2015, down from 0.60 euro paid for 2013, E.ON said.

It also said it had agreed to sell its businesses in Spain and Portugal to Australian energy infrastructure investor Macquarie (>> Macquarie Group Ltd) for 2.5 billion euros, adding that it was considering selling its business in Italy and would conduct a strategic review of its North Sea business.

(Additional reporting by Geert de Clercq in Paris, Emma Thomasson in Berlin and Daniela Pegna and Vera Eckert in Frankfurt; Editing by Anna Willard and Sophie Walker)

By Christoph Steitz