UPDATE 2-Iberdrola dilutes ACS stake with share issue

* At least 1.25 billion euros of shares on the block

* Shares to be offered to institutions, not shareholders

* Co says aims to bolster balance sheet, control costs

* ACS stake diluted 4 percent at today's current prices

* Co to be "more flexible" with 2.18 bln euro divestments (Adds details, analyst, background)

By Jonathan Gleave

MADRID, June 16 (Reuters) - Spanish utility Iberdrola (IBE.MC) surprised investors on Tuesday with plans to issue and sell at least 1.25 billion euros ($1.7 billion) of shares without resorting to a rights issue.

The placement aims to bolster Iberdrola's balance sheet and avoid an escalation in financial costs, but will have the added effect of complicating core shareholder ACS' plans to raise its stake to 20 percent from 12.6 percent

"The icing on the cake from a capital increase would be to potentially dilute Iberdrola's main shareholder ACS," an analyst at a European bank said in a note to clients, highlighting Iberdrola's refusal to allow ACS two seats on its board.

At today's prices, 1.25 bln euros of new shares would dilute stakes in Iberdrola by about 4 percent, although Iberdrola has not decided the price or the amount of new shares on offer.

The European bank analyst said that recent share offerings from energy companies have carried discounts to share prices of about 40 percent.

At today's prices, without discounting the expected decline in Iberdrola's share price tomorrow on dilution concerns, ACS' stake in Iberdrola would fall back to about 12 percent.

"The operation serves a defensive purpose as it is a placement, so Iberdrola can refuse requests for shares from unwanted subscribers," an analyst at a Spanish brokerage said.

PRESSURE OFF ON ASSET SALES

The raising of over 1.25 billion euros of capital through an accelerated bookbuilding with institutions will also ease the pressure on Iberdrola to sell about 2.18 billion euros of assets in 2009 to ease its about 32 billion euro net debt burden.

"We will be able to be more flexible with our divestment program of non-core assets announced to the market," Iberdrola said in a statement.