Reuters first reported on March 21 that U.S.-based Watson was close to buying the Swiss drugmaker to help it compete more effectively against rivals Teva Pharmaceutical Industries and the Novartis unit Sandoz.

The generics sector has seen a wave of mergers in recent years as Western governments pressure the industry to provide drugs at the lowest possible price, favoring large players who can produce at the lowest cost.

Under the terms of the agreement, Watson will make an upfront payment of 4.25 billion euros. Actavis stakeholders also could receive a payment valued at 250 million euros during negotiations should Actavis achieve certain 2012 performance targets, the company said.

Watson said the deal, which is expected to close in the fourth quarter, would immediately add to earnings and estimated annual cost savings and other synergies of more than $300 million within three years. It will also drop its tax rate to about 28 percent from about 36 percent.

Watson, whose recent U.S. sales have been fueled by generic versions of the cholesterol fighter Lipitor, said about 40 percent of its generic revenue will now come from outside the United States, up from 16 percent. The deal will also enhance Watson's business in generic injectable cancer drugs.

"In a single commercially compelling transaction, we more than double Watson's international access and strengthen our commercial position in key established European markets as well as exciting emerging growth markets, including Central and Eastern Europe and Russia," Watson Chief Executive Paul Bisaro said in a statement.

Watson shares rose more than 5 percent in after-hours trading after the deal was announced. Its shares had already climbed more than 18 percent since the Reuters report.

"This is a really good deal from a strategic standpoint," said RBC Capital Markets analyst Shibani Malhotra. "Companies have to be global players to really compete in the generics market going forward."

Acquisition activity has been in high gear across the healthcare sector. In just the past few days, AstraZeneca agreed to buy Ardea Biosciences for $1.26 billion, while Illumina Inc and Human Genome Sciences have rebuffed takeover attempts by Roche Holding and GlaxoSmithKline, respectively. And Amylin Pharmaceuticals is seeking a buyer after spurning a bid by Bristol-Myers Squibb.

Earlier on Wednesday, Amgen Inc agreed to buy Turkish drugmaker Mustafa Nevzat Pharmaceuticals for about $700 million.

GOOD FOR DEUTSCHE BANK

The deal is important also to Deutsche Bank, which was left holding billions of euros of Actavis debt after a leveraged buyout in 2007 by Icelandic tycoon Bjorgolfur Thor Bjorgolfsson.

It comes a day before Deutsche Bank posts first-quarter earnings. Selling down its stake in Actavis will allow Germany's largest lender to free up a capital buffer that it would otherwise need to set aside to meet tougher bank safety rules.

The acquisition is Bisaro's biggest splash since he took over at Watson in 2007 after 15 years at rival generic drugmaker Barr Pharmaceuticals. The CEO has been telling Wall Street he was interested in acquisitions to boost the generics business or its branded-drugs unit that specializes in women's health and urology.

Actavis will add valuable exposure to developing markets in eastern Europe. Fast-growing emerging markets are a key focus for drug companies, as growth stalls in Western countries and pricing pressure increases on off-patent generic medicines.

Watson established a foothold in Europe with its $1.75 billion purchase of Arrow Group in 2009, and then expanded its European presence last year when it bought Greece-based Specifar Pharmaceuticals for $562 million.

Watson ranked fourth by global sales in 2011 among generic drugmakers, while Actavis ranked 14th, according to IMS Health, a healthcare information and services company.

Watson said the deal moves it into third place ahead of Mylan Inc, although IMS data still places Watson fourth.

"We expect investors to be really pleased with this deal. But going forward it's really going to depend on integration and getting things right because this is a very large acquisition for Watson," said RBC's Malhotra.

The company 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, Sigurdur Oli Olafsson, is now head of global generics for the U.S. company.

"He knows it (Actavis) well and he will know exactly where to focus," Malhotra said of Olafsson.

Bank of America Merrill Lynch was financial advisor and Latham & Watkins LLP is acting legal advisor to Watson on the deal, while Blackstone Advisory Partners and Deutsche Bank are acting as financial advisors and Linklaters and Clifford Chance as legal advisors to Actavis.

Watson shares rose to $73.50 in after hours trading from their New York Stock Exchange close at $69.69.

($1 = 0.7585 euros)

(Reporting By Lewis Krauskopf and Bill Berkrot in New York and Ben Hirschler in London; Editing by Leslie Gevirtz, Gunna Dickson and Tim Dobbyn)

By Lewis Krauskopf and Bill Berkrot