(Adds CEO comments, analyst, shares)
By Gwénaëlle Barzic and Leila Abboud
PARIS, July 2 (Reuters) - France's biggest telecom operator Orange has ruled itself out of bidding for smaller rival Bouygues Telecom, causing share prices across the sector to drop on the prospect of the cut-throat competition continuing.
A price war sparked by low-cost player Iliad's arrival to the mobile market in January 2012, has resulted in open talk of consolidation in recent months. Third-place mobile carrier Bouygues has become a target after losing out in a bidding war in April to buy bigger rival SFR to cable group Numericable.
Orange acknowledged in May it was examining what role it could play in French consolidation and sources said that it had held informal talks with Bouygues Telecom.
In a statement issued on Wednesday, the company said: "Orange has examined the possibilities of participating in an operation that would lead to consolidation in the French telecoms market, and believes that it cannot pursue this avenue at the present time as the conditions that the Group has set have not been met."
Orange Chief Executive Stephane Richard said talks with Bouygues foundered over price, and how to allay antitrust concerns over a marriage of number one and three carriers.
"Bouygues demands were too high, and Iliad did not want to go far enough in taking part in putting a deal together," Richard told La Tribune.
A purchase of Bouygues by Orange would likely have required a parallel deal with Iliad, which would buy Bouygues' network and mobile frequencies, to overcome competitive concerns. When Bouygues wanted to buy SFR, it agreed such a deal with Iliad.
"We excluded from the outset just handing Bouygues' network and spectrum to Iliad, like the accord it had with Bouygues if it had won the SFR deal," said Richard.
Orange's decision means that investors' hopes that France would go from four to three mobile operators - along the lines of Germany with Telefonica's purchase of KPN's E-Plus - have been put on hold.
The ball is now back in Iliad's court since it too had discussed a takeover with Bouygues in recent months. They too were far apart on price, so it remains to be seen if direct talks will be rekindled now that Orange has bowed out.
Martin Bouygues, the CEO and controlling shareholder of Bouygues, said on Tuesday he had no intention of being the "sucker" in any consolidation in France, signalling his willingness to hold out for a better price.
"The status quo is back for at least a couple of months probably," said Raymond James telecoms analyst Stephane Beyazian in a research note.
The French government, which owns 27 percent of Orange, could try to get the companies back to the negotiating table.
Economy Minister Arnaud Montebourg has said the government supports a reduction of the number of mobile players to three because intense competition in the sector is jeopardising jobs and investment in high-speed broadband.
Jerry Dellis, an analyst at Jefferies, predicted that "more active government intervention is likely to re-energise the process in due course."
Shares in Bouygues closed down 1.8 percent to 29.78 euros. Iliad finished 3.4 percent lower, and Orange 3.7 percent lower.
Shares in Numericable, which is buying Vivendi's SFR, the market's second biggest operator behind Orange, dropped 2 percent to 43.75 euros.