UPDATE 4-Telefonica to increase hold over Telecom Italia
* To lift stake in holding that controls Tel Italia
* Will need regulatory approval to take full control
* Deal increases Telefonica's influence at limited cost
* Prevents third party from taking control
* Deal likely to face intense public scrutiny in Italy
* Telefonica shares steady, Tel Italia up 3.3 percent
By Danilo Masoni and Stefano Rebaudo
MILAN, Sept 24 (Reuters) - Spanish telecoms group Telefonica has struck a deal to gradually secure control of Telecom Italia and its lucrative south American business without having to launch a full takeover bid.
The multi-part 860 million euro ($1.16 billion) cash and shares deal secured on Tuesday will allow Telefonica to raise its stake in Telco, the holding company controlling about 22 percent of Telecom Italia, allowing Telco's other investors, Intesa Sanpaolo, Generali and Mediobanca to eventually bow out.
Telefonica, which has debt of nearly 50 billion euros ($67.46 billion), wanted influence over what happens to Telecom Italia and its prized Brazilian mobile unit Tim Participacoes but at minimal cost.
Still, the deal has yet to receive the approval of Brazilian regulators, who could force Telecom Italia to sell TIM Participacoes if Telefonica acquires full ownership of Telco, a source at Brazilian telecom regulator Anatel told Reuters.
Despite its own debt burden of nearly 29 billion euros ($39.13 billion) and sinking margins at home, Telecom Italia was viewed as a potential takeover target, attracting interest from Egyptian tycoon Naguib Sawiris and Hong Kong-based Hutchison Whampoa, while U.S. telecoms group AT&T has also had contacts with the firm, people close to the matter have said.
The agreement ends months of speculation over the future of Telecom Italia which is seeking capital to cut its debt, but is likely to face scrutiny at a prospective break-up of Italy's biggest telecoms group as well as possible lay-offs.
Junior economy minister Antonio Catricala ruled out on Monday a government intervention to keep the former state monopoly under national control but expressed his support for a plan to sell the company's fixed-line network, Italy's most sensitive telecoms infrastructure, to a state-backed fund.
The government's decision not to intervene could have implications for other large Italian groups, such as Alitalia which is being stalked by Air France-KLM, adding to the list of large Italian groups which have been acquired by foreign shareholders.
For the time being the Spanish group has ensured its Italian partners looking to cut their unprofitable investments in Telecom Italia do not sell out to a rival.
"We believe this additional investment made by Telefonica in Telco was the price the company was willing to pay to keep its options open at Telecom Italia and keep at large any other third party that could be interested in Telecom Italia and especially its Brazilian assets," Espirito Santo analysts said.
Telefonica could push for a sale and break up of the Brazilian operations which analysts have estimated to be worth around $10 billion.
Telefonica will increase its stake in Telco via two capital increases to 66 percent and then 70 percent. Telco has control of Telecom Italia because it appoints a majority of members to its board.
The deal values Telecom Italia shares at 1.09 euros each. That is nearly twice current market prices, but below book value for two of Telco's investors - all of which have repeatedly booked losses since taking control in 2007.
Telefonica shares closed at 11.29 euros, while Telecom Italia's gained 1.7 percent to 0.60 euros.
Telefonica will use some of its shares to pay down some of Telco's debt. But its voting rights in Telco will remain unchanged at 46 percent - and it will not be able to fully buy out its Telco partners - unless the plan is approved by antitrust regulators, including those in Brazil.
The Italian investors in Telco will retain the right to unwind the shareholder pact they share with Telefonica in June 2014, leaving some uncertainty.
"The deal brings no benefit to minority shareholders since it's all at the holding level," said Stefano Fabiani, a fund manager at Zenit Sgr. "But valuing Telecom Italia shares at 1.09 euros has set a theoretical upside and if tomorrow there's any offer, that can't go unobserved."
Italy's telecoms sector is already largely controlled by foreign capital. Britain's Vodafone owns the country's second-largest mobile operator, while Swisscom owns the second-biggest fixed-line player, Fastweb
Italian unions said on Tuesday the Telefonica deal was worrisome because it did not solve Telecom Italia's debt problems and may limit its capacity to invest.
The two main parties supporting Letta asked on Tuesday the government to testify in parliament over Telecom Italia.