* Regulator argues that TV advertising market is too tough
* TF1 CEO says "likely" that LCI will close after Dec 31
* Ruling is still positive for the sector -Exane analyst (Adds "Le Monde" shareholders' interest paras 11-12)
By Gwénaëlle Barzic and Leila Abboud
PARIS, July 29 (Reuters) - France's broadcast regulator has rejected applications from TF1, M6 and Vivendi's Canal+ to shift three of their respective pay-television channels to free-to-air, dealing a setback to the companies and their staff.
The CSA said in a statement on Tuesday that it based the decision largely on the fact that the advertising market remained weak and there were not enough marketing dollars to go around for free-to-air channels.
It also said some of the last crop of free channels that launched about two years ago could be put at risk if the shift was approved.
TF1 had applied to take its 24-hour news channel LCI from paid to free, while M6 wanted the same for its high-end cultural channel Paris Premiere. Canal+ applied to move its documentary channel Planete+.
A government source who has followed the case agreed that approving three new free channels in the current "morose" advertising market was not a good idea. The person added that the regulator would have been vulnerable to legal challenge if it had approved only one or two of the channels and not all.
The ruling casts doubts over dozens of jobs at LCI and Paris Premiere. Both TF1 and M6 had said they did not see a viable future for the channels unless they switched to free-to-air.
The CSA did however leave the door open on revisiting the issue, highlighting that its ruling was based on the current state of the advertising market. "A more favourable evolution of the market could justify looking at the issue again in the future," it said.
LCI SHUTDOWN "LIKELY"
Both TF1 and M6 had lobbied hard for the changes.
Tuesday's ruling could lead to lay-offs among LCI's 247 staffers. Asked by reporters if the channel could shut down after Dec 31 as a result of the ruling, TF1's chief executive Nonce Paolini said, "as things stand, that's likely".
"Everyone knows that LCI has no future in pay-TV," he said, adding that TF1 was studying its options and whether to appeal against the ruling.
Just an hour later, the shareholders of French daily newspaper Le Monde said they were interested in taking over LCI and would reach out to LCI's shareholders in the coming days.
TF1's Paolini had stressed that "LCI is not for sale".
LCI, which launched 20 years ago as France's first 24-hour news channel, is now trailing behind its free-to-air rivals iTele, owned by Canal+, and BFM TV from NextRadioTV.
M6 said in a statement that it "vigorously contested" the CSA ruling that threatened the future of Paris Premiere, adding that it would consider an appeal.
Separately on Tuesday, M6 reported a sharp decline in advertising revenue in the second quarter because of weak demand and the fact it did not broadcast the soccer World Cup, unlike larger competitor TF1.
Canal+ said in a statement that the CSA's decision was "wise and responsible" given the current state of the television market in France. The group had only asked for Planete+ to move to free-to-air because it feared that the switch of key channels such as LCI and Paris Premiere would have hurt the prospects of pay-TV as a whole.
Exane BNP Paribas analyst Adrien de Saint Hilaire viewed the ruling "as positive for the whole French TV landscape" because TF1 and M6 would have needed to invest heavily to make the channels free.
"TF1, and potentially M6, are now likely to close down those channels, which are loss-making for LCI or just break even for Paris Premiere," he said in a note. "This could pave the way for in-market consolidation and market repair."
Shares in TF1 closed roughly flat and shares in M6 up 0.3 percent, while the French blue-chip CAC 40 index rose 0.5 percent. (Additional reporting by Julien Ponthus, Natalie Huet and Matthieu Protard; Editing by Greg Mahlich)