ANALYIS-EU rebuff won't free Aer Lingus from Ryanair grip
* EU set to end Ryanair's seven-year Aer Lingus pursuit
* Ryanair 30 pct stake gives it grip of rival
* Irish govt may struggle to offload its 25 pct stake
DUBLIN, Feb 26 (Reuters) - The European Commission looks certain to end Ryanair's seven-year pursuit of Aer Lingus, but Brussels can't stop the low-cost carrier from using its stake to keep its rival in limbo for years.
The Commission, which acts as Europe's anti-monopoly watchdog, has told Ryanair it will reject its 694 million euro ($917 million) bid in an announcement expected on Wednesday.
A veto, which would be the first time it has twice rejected a proposed takeover, could force Ryanair chief Michael O'Leary to decide whether to finally set its smaller rival free by selling its 30 percent stake.
But if O'Leary follows through on a threat to attempt to become the first company in a decade to overturn an EU anti-monopoly decision, the process could tie up the stake for years.
It would also likely scare off other strategic investors and stymie the Irish government's efforts to offload its own 25 percent stake - part of a package of privatisations required by its 85 billion euro EU-IMF bailout.
"The government and Aer Lingus will simply have to wait and see what Ryanair chooses to do," said analyst David Holohan at brokerage Merrion Capital. "Until the Ryanair process is completed, I think the government will struggle to find a buyer."
Aer Lingus, long since eclipsed in terms of the number of passengers carried by its budget rival, has made no secret of its wish to remove Ryanair from its share registry, arguing Ryanair uses its 30 percent shareholding to disrupt and distract its one significant competitor on the Irish market.
Dropping Ryanair would also clear the way for an investment by a large industry investor with deep pockets, like minority shareholder Etihad, or boost the company's "free float" of readily tradeable shares, which Aer Lingus believes would help lift its share price.
Yet if O'Leary decides to appeal, Aer Lingus' best hope may be a probe by Britain's Competition Commission into whether the Ryanair holding distorts competition in the UK market.
The investigation has been delayed by the European probe and even if it is restarted, Ryanair could likely use appeal processes to delay a final decision for more than a year.
The threat of being forced to sell could put pressure on Ryanair to sell its stake sooner. But having already written down the 407 million euros it paid for the stake in 2007-2009 to 80 million, it may feel it has some leeway given current prices valuing it at around 200 million euros.
The Irish government has maintained a wait-and-see approach to its stake as the probe proceeds, hiring consultants to provide market intelligence ahead of a possible sale, but has not yet launched a public tender for financial and legal advisors.
"We will sell the stake at the right time at the right price and under the right conditions," Transport Minister Leo Varadkar told Reuters last week. "I don't feel any pressure."
Equally, a decision forcing Ryanair to sell its stake would "open up all kinds of opportunities" for the government's stake, Varadkar said.
The two carriers linked to the stake are British Airways parent ICAG - whose chief Willie Walsh used to run Aer Lingus and which offered to take over some Aer Lingus routes as part of Ryanair's bid - and Abu Dhabi carrier Etihad.
Etihad has said it may be interested in increasing its 3 percent stake, while ICAG's Walsh has said he would not be interested. Both companies declined comment when asked if the EU commission decision might change their mind.
Ryanair's other option would be to target institutional investors keen to get exposure to one of Europe's few profitable airlines, with operating profit of 69.1 million euros in 2012, up 40 percent from last year.
Even if Ryanair decides to offload Aer Lingus, the latter's management still needs to address a deficit of around 500 million euros in a shared pension scheme associated with current and former Aer Lingus staff.
Aer Lingus, whose market capitalisation is 668 million euros, says it has no legal obligation to make good the deficit, but the threat of legal and industrial action has kept it at the negotiating table.
The airline and unions have said they hope for a deal within months.
"Until the pension issue is resolved, we suspect that prospective suitors will be cautious," said Gerard Moore, an analyst at brokerage NCB. ($1 = 0.7567 euros) (Editing by David Holmes)