UPDATE 3-Telefonica gives up on PT's Vivo stake, courts beckon

* PT request for more time meets with faxed answer 'no'

* Telefonica could seek new avenue for control

* Legal battle will likely ensue

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By Nigel Davies

MADRID, July 17 (Reuters) - Spain's Telefonica dropped its offer for Portugal Telecom's stake in Brazilian cellphone company Vivo on Saturday, declining a request for more time from its Portuguese partner and setting the stage for a legal battle over Vivo's future.

The Portuguese carrier asked for more time to cement a deal, but Telefonica had clearly lost patience after PT's shareholders voted in favour of the 7.15 billion euro bid for Vivo last month but that move was then overruled by the Portuguese government. [ID:nLDE65T0MI]

"Telefonica announces that after Portugal Telecom's board did not accept the offer within the agreed time the offer has been dropped," Telefonica said in a statement.

The refusal to give PT more time could mean Telefonica (TEF.MC) aims to buy the free-floating shares in Vivo on the Brazil bourse, but it will first have to seek legal arbitration to dissolve Brasilcel, the company through which it and PT (PTC.LS) own 60 percent of Vivo VIV04.SA, analysts said.

"Arbitration may take some months but Telefonica has probably decided that option is better than effectively being blackmailed by the Portuguese government after PT's own shareholders accepted what everyone agrees is a very good offer," said a senior telecoms analyst in Madrid who declined to be named.

Telefonica has been vying for control of Vivo for years, aiming to merge the unit with its struggling fixed-line business Telesp in Brazil, producing 2-4 billion euro in synergies, according to analysts, and giving it a firmer foot in the fast growing Brazilian market.

It faces stiff competition there from its biggest rival, Carlos Slim's America Movil (AMXL.MX), which is already integrating its fixed and mobile businesses. Full control of Vivo would oftset the impact of slowing revenues from Telefonica's largely mature businesses in Europe.

Portugal Telecom ended a board meeting late on Friday without reaching a decision on whether to accept Telefonica's bid for its stake in Vivo. Although the offer is deemed by analysts to be generous, PT would be relegated to becoming an almost purely domestic carrier if its participation in Vivo were sold.

PT said in a fax, sent 21 minutes before the midnight deadline, that talks had progressed with Telefonica in a constructive manner and it was committed to finding an agreement that satisfied all parties. The request was denied in a faxed response, and confirmed in a statement to the Spanish market regulator on Saturday.

Telefonica's deadline had already been extended once after the Portuguese government blocked the transaction two weeks ago by using its golden share in Portugal Telecom.

A majority of Portugal Telecom shareholders had voted in favour of the deal just ahead of the government's intervention.

The European Court of Justice later said the use of the golden share breached EU rules on the free movement of capital. (Additional reporting by Elisabeth O'leary; Editing by Toby Chopra)