United Technologies Corp. today dropped out of the bidding in the takeover battle for Babcock & Wilcox Co., conceding defeat to the more aggressive J. Ray McDermott & Co. of New Orleans.

UTC said it "no longer was in the best interests" of its shareholders to continue to fight for B&O. That announcement followed a move earlier in the day by McDermott which effectively increased the McDermott offer to $65 a share.

The Louisiana-based oil rig contractor, reversing an earlier decision, said it would pass along to Babcock shareholders who tendered their holdings to McDermott all of the $2,50 a share special dividend declared by B&-W Wednesday. The dividend, combined with McDermott's final offer of $62.50 a share, makes the total bid $65.

McDermott also said it had obtained the minimum 2.5 million shares it sought by its 6:30 p.m. EDT Wednesday deadline. It also increased to 4.8 million from 4.5 million shares the amount of stock it is seeking overall Its latest offer is open to shareholders until 12:01 a.m. EDT Sept. 3.

McDermott owns 1.2 million shares already. By acquiring 4.8 million more of the 12.2 million shares outstanding, it will control just under 50 per cent of B&-W.

A United Technologies spokesman said the company is in the process of releasing all tenders of B&-W stock that it had received under its cash offer, which was withdrawn about noon yesterday. UTC declined to disclose how many shares had been tendered to it. Its final offer had been $58.50 a share, plus half of the special dividend declared by the Babcock board, or $59.75.

McDermott's tenacity in the tender war was a blow to United Technologies' chairman Harry J. Gray.The acquision of B&-W would have jumped UTC, a Hartford-based aerospace conglomerate, from its place as the nation's 35the largest industrial company in sales to 19th.

B&-W's chairman George G. Zipf, who has made known his strong opposition to a merger with any company headed by Gray, persuaded the board and Babcock's counsel to oppose the UTC overture vigorously on antitrust grounds. B&-W is a leading manufacturer of nuclear- and coal-fired boilers.

B&-W's board began the fight against UTC confidently, apparently believing that it would not fall victim to any acquisitor. When UTC made its first public bid in March, B&-W began filing state and federal lawsuits based on the classic takeover defenses of inadequate offer, procedural violations of state tender offer statues and federal antitrust violations.

But as it lost rould after successive round of court battles, it began a search for a "white knight," in takeover parlance a friendly company that it would prefer as a merger partner.

In May, with Babcock's confidence still intact, it had slapped a lawsuit against McDermott. The suit alleged that McDermott's acquisition of 10 per cent of Babcock stock was a covert takeover attempt.

But as UTC chalked up courtroom victories and then escalated its cash offer to Babcock shareholders. B&-W looked to McDermott as a possible savior. As the confidence of its board eroded. B&-W publicly endorsed McDermott's competing offers.

McDermott will pay nearly $300 million for the 4.8 million shares it wants. Both McDermott and B&-W have set up negotiating committees which are scheduled to meet Sept. 7 to being full merger talks.

Wall Street professional arbitrageurs are the big winners in the three way fight, analysts said. Arbitrageurs began buying B&-W stock last March when the first hints of an acquisition attempt were whispered on the Street. At that time the stock was trading for less athan $35 a share. The market price had risen to $57.50 a share as of the New York Stock Exchange close Wednesday, The professional traders guaranteed themselves a profit in either of two ways: by selling on the market as acquisitions news buoyed the price or by cashing in to the winning bidder in the takeover.