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* NZME and Fairfax own 90 pct of New Zealand newspapers
* Merger would reduce quality, diversity: regulator
* NZME shares slump as much as 16 pct, Fairfax loses up to 3.2 pct (Recasts, adds company and analyst comments)
By Charlotte Greenfield and Jamie Freed
WELLINGTON/SYDNEY, May 3 (Reuters) - New Zealand's competition regulator blocked the planned merger of the nation's two largest publishing groups, saying the deal would have led to unprecedented local media influence and built the world's most concentrated newspaper market outside of China.
The decision will force NZME Ltd and Fairfax Media Ltd's New Zealand unit to find alternative strategies to deal with heavy competitive pressure and the loss of advertising dollars to digital rivals such as Alphabet Inc's Google and Facebook Inc.
NZME and Fairfax control nearly 90 percent of New Zealand's newspapers and clearance for the deal could have set a precedent for increased concentration in the future in neighbouring Australia, where Rupert Murdoch's News Corp and Fairfax are the dominant players and are under similar financial stress.
New Zealand Commerce Commission (NZCC) Chairman Mark Berry said the planned merger would have concentrated media ownership and influence to an "unprecedented extent" for a well-established modern liberal democracy.
“Having reviewed all the evidence, our primary concerns remain that this merger would be likely to reduce both the quality of news produced and the diversity of voices (plurality) available for New Zealanders to consume," he said in a statement on Wednesday.
The competition watchdog had twice delayed its final decision as it heard arguments from the two companies on why the increasing media diversity from the growing number of digital operations meant the deal should be allowed to go ahead.
NZME owns the Auckland-based New Zealand Herald, the country's top-selling newspaper, and Fairfax publishes the main papers in the other major cities, Wellington and Christchurch, as well as popular website stuff.co.nz.
Under the proposed deal, NZME would have paid NZ$55 million for Fairfax's New Zealand operations. It would also have issued new shares to allow Fairfax to hold a 41 percent stake in NZME.
Combining the assets would have helped to cut costs by up to NZ$200 million ($138.98 million) over five years, the two companies said.
Fairfax Chief Executive Greg Hywood said his company would focus on cost cutting in New Zealand after the NZCC decision. "Further publishing frequency changes and consolidation of titles is an inevitability," he said in a statement.
NZME Chief Executive Michael Boggs told Radio NZ his company could consider buying some of Fairfax's smaller papers if they were divested.
Daniel Mueller, a senior analyst at Forager Funds Management which owns a 9 percent stake in NZME, said that company was in a stronger position than Fairfax in New Zealand because it also had sizeable radio assets and more potential for online growth.
"We think they can stabilize earnings for the medium term rather than some other media companies that are in pretty rapid decline," he said.
Fairfax and NZME have the option of appealing the NZCC decision to the High Court within 20 business days.
NZME shares fell as much as 16 percent on Wednesday, while Fairfax shares were down as much as 3.2 percent.
Separately, Fairfax said on Wednesday it would shed another 125 jobs at its Australian newspapers. The union representing journalists at Fairfax in Australia said staff had voted to strike work for seven days as a result of the cuts.
A Fairfax spokesman did not respond immediately to a request for comment. ($1 = 1.4391 New Zealand dollars) (Reporting by Charlotte Greenfield and Jamie Freed; Editing by Jonathan Oatis and Muralikumar Anantharaman)