(Reuters) -Ubisoft shares reversed gains in afternoon trade on Friday after rising as much as 12% earlier on plans to set up a subsidiary to house three of its popular video game franchises.

The stock was down around 1% at 1451 GMT after dropping as much as 6% at one point, with an analyst citing a trading source who said U.S. hedge funds are shorting the stock given Ubisoft will pay down only 500 million euros of debt in the deal.

The French company said that Tencent ( TCTZF ) will invest 1.16 billion euros ($1.26 billion) in the new unit in exchange for a stake of about 25%.

In a bid to recover from underperformance by some of the company's main titles, the Guillemot family, Ubisoft's founder and largest shareholder, began exploring talks with the Chinese tech giant in September.

Ubisoft said the new unit would be valued at around 4 billion euros and will bring together its popular "Assassin's Creed", "Far Cry" and "Tom Clancy's Rainbow Six" franchises.

It added the deal would help it to reduce net debt, which stood at 1.1 billion euros at the end of September.

Should the deal close by the end of 2025, the group's debt situation will become much more comfortable, Barclays analysts said on Friday.

"This operation highlights the group's significant undervaluation, which could lead to a slimming down of the rest of its business," broker Midcap Partners said.

Ubisoft lost almost half of its stock market value last year as the company reported results below expectations and warned about dropping sales and delayed game releases.

"The Tencent ( TCTZF ) deal is a strategic corrective move for Ubisoft," Erste analysts said in a note.

($1 = 0.9241 euros)

(Reporting by Johan Bodinier and Alessandro Parodi, additional reporting Lucy Raitano and Olivier Cherfan; editing by David Evans, Jane Merriman, Joe Bavier and David Gregorio)