The UK coffee shop market is continuing to speculate about a potential merger between rivals Coffee Republic and Caffe Nero.

Caffe Nero revealed on Thursday that it had built a 10.69% stake in its rival, up from 4.3% on Tuesday.

Coffee Republic, meanwhile, has admitted receiving a takeover approach but is staying tight-lipped about who this has come from.

Analysts said there was considerable logic in a merger between the two companies, but also suggested Coffee Republic could be an attractive brand for larger companies such as supermarket groups.

Quality brand association

Caffe Nero has so far maintained that it has only bought the shares as a value investment.

The clues are out there, and Caffe Nero seems quite logical on so many counts

Mark Hughes, Numis Securities

In the last 18 months, Coffee Republic shares have slumped from 30p to just 2p, before the takeover speculation boosted them to nearer 5p.

This gave them a market value of about �5m, which is considered cheap for a firm with almost 100 high street outlets.

Analyst Mark Hughes at Numis Securities suggested Nero chief executive Gerry Ford was a "shrewd operator thinking one of two things".

Either Mr Ford would make a bid or, if someone else bought Coffee Republic, he could "make some good short-term money".

Mr Hughes said there was some logic in a large company such as a supermarket chain buying Coffee Republic, or entering into partnership with it.

Leisure conglomerate Whitbread owns one of the UK's top two coffee chains, Costa.

But Mr Hughes added: "Trawling through all the clues out there, Caffe Nero seems quite logical on so many counts".

Someone has to go

Coffee Republic has looked vulnerable to a bid for since the start of the year, when it warned on slowing sales and, six months later, halted its expansion.

Analysts have also been calling for consolidation in the past year.

They say there are currently four big operators in the UK market - US market leader Starbucks, Costa, Coffee Republic and Caffe Nero - but only room for three.

Mr Hughes said: "The market will eventually transform itself into just three key operators".

Caffe Nero would therefore be likely to gain considerable City support, should it choose to make an offer for Coffee Republic, he added.