A tie-up in the coffee shop market appears to finally be brewing as Caffe Nero takes a stake in rival Coffee Republic and the latter confirms an approach.

Analysts have long been expecting consolidation within the coffee bar sector as it becomes increasingly competitive and operators struggle to make a profit.

For a company as cash consumptive as them, it doesn't make sense to tie up capital for no reason

Greg Feehely, Old Mutual Securities

And as Caffe Nero - the largest UK-owned coffee chain - on Tuesday revealed a 4.32% stake in its competitor, analysts predicted this was not a token gesture.

A day later, Coffee Republic admitted it had received an approach but would not confirm, nor deny, that it was from Caffe Nero.

Coffee Republic has looked increasingly vulnerable in recent months after losing key directors and being forced to halt its expansion plans.

All froth no profits?

The UK coffee bar market has grown rapidly in the last few years, and the four key operators are now US market leader Starbucks, Costa Coffee - owned by leisure group Whitbread - Caffe Nero and Coffee Republic.

But, as each chain pushes its own roll-out, the market has become increasingly saturated, particularly in London.

Leisure analyst Greg Feehely at Old Mutual Securities told BBC Business Online that market watchers have been calling for some form of consolidation for months as there is no longer room for four large operators.

Poor relation

Coffee Republic has struggled to keep pace with rivals and in January was forced to admit it would not break even in the first half of this year, as originally hoped.

Last month, the chain said it was stopping its expansion programme and selling 18 of its poorly-performing bars.

Caffe Nero meanwhile has been growing aggressively, buying the Aroma chain of 26 coffee shops from McDonald's in February and raising �5m on the stock market to fund its expansion.

No time for idle investments

Analysts agree that Caffe Nero founder Gerry Ford is a shrewd businessman and would not spend money on a speculative investment when he has raised cash to grow his own chain.

Mr Feehely said: "It's not as if Caffe Nero doesn't have needs elsewhere.

"For a company as cash consumptive as them, it doesn't make sense to tie up capital for no reason."

The market was clearly cheered by hopes of consolidation, with shares in Coffee Republic jumping 38% on Tuesday to 5p per share.

This is still a far cry from its value at the start of 2001, when enthusiasm for the sector was at its height and Coffee Republic was valued at 30p per share.

One analyst told BBC on Tuesday: "At the end of the day, it comes down to what Gerry wants to pay. Coffee Republic may have no choice but to sell."