UPDATE 3-France Telecom aims to limit margin erosion

* H1 EBITDA 8.821 billion euros, higher than expected

* Q2 EBITDA margin 35.4 pct, up 0.2 points

* CEO sees difficult market in H2, targets cost cuts (Adds guidance detail, Zain comment, share price)

By Cyril Altmeyer

PARIS, July 30 (Reuters) - France Telecom (FTE.PA) posted higher-than-expected first-half operating income on Thursday but warned of a slowdown in activity in the second half and increasing cost pressure due to regulatory decisions.

Chief Executive Didier Lombard said in a statement that the economic environment had deteriorated more than expected over the course of the first half, but the first results of cost-savings efforts had helped mitigate the effects of the slowdown. France Telecom shares were up 2.5 percent at midday.

"For the second half, with the economic environment remaining difficult, the group will continue with targeted marketing programs and cost-reduction efforts. We are confident we can adjust to current conditions while preparing to take maximum advantage of the recovery when it occurs," he added.

The French former state-owned incumbent operator, which holds the Orange brand name, said its core operating profit margin slipped 0.7 percentage points in the first half but rose 0.2 points in the second quarter. Finance director Gervais Pellisier said he expected a similar decline in the second half.

Pellisier added the company might look at some of the African assets of Kuwait's Zain (ZAIN.KW) if the latter decided to sell them in parts. Vivendi (VIV.PA) recently broke off talks about a buy of Zain's African assets in one block.[ID:nLK21650]

France Telecom's first-half sales slipped 0.5 percent on a comparable basis.

It said it would try to limit margin erosion through cost cuts it had already announced.

The group confirmed its 2009 target for organic free cash flow of 8 billion euros ($11.28 billion) after it generated 4.1 billion in the first half.

The group posted earnings before interest, tax, depreciation and amortisation of 8.821 billion euros for the first half, versus an average expectation of 8.641 billion in a Reuters poll of 12 analysts.

Spain's Telefonica (TEF.MC) also beat expectations on Thursday with a first-half net profit of 3.62 billion. [ID:nLU429898]

France Telecom's net attributable income for the first half was 2.579 billion, up 2.3 percent.

The group confirmed its debt reduction policy and said it would maintain a dividend distribution rate of at least 45 percent of organic cash flow. It planned to pay an interim dividend of 0.60 euros per share in September.

France Telecom said its 2009 cash generation target was excluding the potential acquisition of new mobile frequencies.

It said it expected the impact of regulatory measures in the second half to be twice that of the first half, taking into account various reductions in mobile call termination rates.

France Telecom said the rate of investment would be higher in the second half compared to the first, while the level of cost reduction would be comparable. (Reporting by Marcel Michelson; Editing by John Stonestreet and Rupert Winchester)