(Reuters) - Google Inc said it would acquire video compression software maker On2 Technologies Inc for $106.5 million, stepping up efforts to foster the spread of Internet video.

The stock deal, which represents a 57 percent premium to On2's Tuesday closing price, is Google's first acquisition of a publicly traded company.

On2's technology shrinks video files, making it easier to send video across the Internet. It has become increasingly important as more people watch and share videos online.

Google, which bought popular video sharing site YouTube for $1.65 billion in 2006, could use On2's software to drive down the cost of producing and distributing Internet video.

"As you think about how important video delivery is for Google, controlling the mechanisms for compression is probably a next logical step," said Thomas Weisel Partners analyst Christa Quarles.

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Although YouTube is the top U.S. video site, Google has lost money on it because it costs a lot to stream billions of videos, with only a tiny swathe of them being supported by advertising.

Google is also expanding into new markets such as handheld electronic devices that use its Android operating system. Last month, the company announced plans to release an operating system for PCs dubbed Chrome OS.

With On2's video technology, Google could field its own software that allows videos to play on PCs and mobile devices, creating a rival to Microsoft Corp's Windows Media, Apple Inc's QuickTime and Adobe Systems Inc's Flash, analysts said.

Google could also use the technology to build an application that competes with Skype, the popular Web-based voice and video calling company that parent eBay Inc plans to spin off, Merriman Curhan Ford analyst Richard Fetyko said in a note to investors.

Adobe and Skype currently license On2 technology.

By owning On2's video compression technology, Google could avoid paying licensing fees to shrink YouTube videos, which could save the company tens of millions of dollars a year, Fetyko said.

Shares of Google were off slightly at $451.34 in afternoon Nasdaq trade. Shares of On2, which are traded on the American Stock Exchange, rose to 58 cents on Wednesday.

DEAL TERMS

Each outstanding common share of On2 will be converted into 60 cents worth of Google Class A common stock under the deal.

On2 Technologies was founded in 1992 as the Duck Corporation, but merged with another company in 1999 and became On2. The company has lost money for the past five years and had $16.3 million in revenue in 2008.

In a blog post announcing the deal on Wednesday, Google said it would not reveal specific product plans until after the deal closes.

Google does not break out YouTube's financial performance, but analyst estimates of its losses this year range from $174 million to $470 million.

Google executives said in July that YouTube would be profitable in the near future.

The main alternative to On2's technology, the H.264 standard, requires companies to pay licensing fees that aren't cheap, Gartner analyst Andrew Frank said.

While On2 also charges fees, Frank said that Google will have the option to make the software as low-cost and as open as it feels is necessary to make Internet video proliferate.

Separately, Google has sold its Google Radio Automation business, which created software to automate broadcast radio programing, to privately held WideOrbit Inc.

(Reporting by Alexei Oreskovic, additional reporting by Franklin Paul in New York; Editing by Leslie Gevirtz)