Telecom Italia hasn't lost sparkle for Telefonica

LONDON (Reuters) - The scandal around Telecom Italia unit Sparkle is unlikely to dim Telefonica's appetite for its Italian rival, whose Latin American assets it covets to keep arch rival Carlos Slim in check.

A wide-ranging probe into a 2-billion-euro money-laundering ring has implicated Telecom Italia Sparkle and Fastweb -- Italy's second-biggest telecoms operator -- sending shockwaves through Italy's telecom industry.

But Sparkle is too small to derail talks between Spain's Telefonica and Telecom Italia, bankers say, and the business case for an acquisition still stands -- expansion into fast-growing South America.

"Telefonica needs to be mindful of its strategic position against Slim," a senior London-based telecom banker said.

Slim, the world's richest person, is integrating his America Movil with other groups he controls across Latin America into a provider with 250 million customers, more than Telefonica's 169 million Latin American subscribers.

To keep pace with the Mexican billionaire, Telefonica should take full control of a Brazilian operator, the banker said.

It does not have many options though. It shares control of Vivo, Brazil's top mobile company, with Portugal Telecom, which would be loath to sell its stake to its Spanish rival, according to a second investment banker.

"There is no clear path to control of Vivo and mobile is where all the growth and value is coming from," the first banker said, estimating that the Brazilian mobile market is growing by about 15 percent a year.

America Movil is the second-largest player in the region, so Telecom Italia -- which controls TIM Brazil, the number three Brazilian mobile company -- holds a key asset.

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Telecom Italia will approve its 2009 results on Thursday after delaying finalizing the numbers as it sifted through a 1,600-page court order on the racket that laundered money via fake sales and purchases of phone services.

Bankers do not expect Telefonica to bid until the probe of the Sparkle subsidiary is over, and Telefonica sent a strong signal the deal is on hold when saying in February it was comfortable with its current stake in Telecom Italia.

Telefonica has spent a good part of the last month reassuring investors that its energy is focused on extracting maximum synergies out of its current investment in Telecom Italia, rather than deepening ties.

An eventual deal between Telefonica and Telecom Italia would also be politically complex, requiring the blessing of Spanish and Italian authorities.

Rome has been wary of letting the Italian phone network fall into foreign hands, but Telefonica is unlikely to be interested in Telecom Italia without the prized phone network that contributes the bulk of its earnings.

Signs of a turnaround in Telecom Italia mean Telefonica will not want to wait too long.

"Telefonica will be interested in buying Telecom Italia while it is still cheap," said Michael Kovacocy, a Daiwa Securities analyst who believes a deal is more than 80 percent likely in the next eighteen months.

Telecom Italia shares have been languishing just above 1 euro for the past five months.

"Any buyer would want to wait until the outcome (of the probe is clear) but this doesn't move the needle in the wider scheme of things," a third banker said.

(Additional reporting by Elizabeth O'leary in Madrid, Deepa Babington in Rome and Georgina Prodhan in London, Editing by Sitaraman Shankar)