Rewrites throughout, adds deal value in paragraph 1, consultant comment in paragraph 5

By Hritam Mukherjee and Nishit Navin

Jan 1 (Reuters) - India's KFC and Pizza Hut operators Sapphire Foods SAPI.NS and Devyani International DEVY.NS said on Thursday they will merge in a $934 million deal, creating a fast-food franchisee powerhouse in the world's most populous country.

The deal comes as India's fast-food franchisees grapple with higher costs, slowing same-store sales and margin pressure, while facing stiff competition from McDonald's MCD.N and Domino's Pizza DPZ.O operators in a market where consumers are cutting back on non-essential spending.

Devyani will issue 177 shares for every 100 shares of Sapphire as part of the deal and it expects annual synergies of 2.1 billion to 2.25 billion rupees ($23.34 million to $25.01 million) from the second full year of operations of the combined entity.

The companies, partners of Yum Brands YUM.N, run more than 3,000 outlets across India and overseas, including KFC and Pizza Hut dine-in restaurants and compete with the Indian operators of McDonald's and Domino's Pizza chains - Westlife Foodworld WEST.NS and Jubilant Foodworks JUBI.NS.

Both the KFC and Pizza Hut franchisees in India operate at a net loss, making scalability a challenge, said Akshay D'Souza, an independent consumer goods consultant.

"With the single entity, if they are able to unlock even half of the expected synergies, we will be seeing a profitable enterprise... where they can control costs better."

In the quarter ended September, Sapphire's consolidated total costs rose 10% on-year to 7.68 billion rupees, while Devyani's spends rose 14.4% to 14.08 billion rupees.

Devyani reported a net loss of 219 million rupees for the quarter ended September 30, reversing a profit of 170,000 rupees a year earlier, while Sapphire posted a wider consolidated net loss of 127.7 million rupees, compared with a loss of 30.4 million rupees a year ago.

($1 = 89.9625 Indian rupees)

(Reporting by Hritam Mukherjee, Nishit Navin and Nandan Mandayam, writing by Chandini Monnappa; Editing by Howard Goller and Ros Russell)

((Hritam.Mukherjee@thomsonreuters.com; X: @MukherjeeHritam;))