Sarkozy steps up pressure on Suez for GDF merger

PARIS (Reuters) - Suez needs to give up its historic water business to allow a delayed merger with Gaz de France to go ahead, French President Nicolas Sarkozy said on Thursday, in what could turn out to be a deal breaker.

A source close to Suez (LYOE.PA) said there was no question of the private utility group selling off its water and waste management activities to salvage the 90-billion-euro ($122.5 billion) deal with the gas group GAZ.PA.

This suggested the sides will not be able to resolve the differences over valuation that have delayed an 18-month old plan to build a European electricity and gas champion.

Suez shares rallied 3.8 percent to 40.40 euros as investors speculated the GDF deal would fall through, turning Suez again into a possible takeover target, according to traders.

"Suez totally excludes selling its environment assets even if it means that the merger does not go through," the source told Reuters, adding environment activities were essential to Suez's business in China and the Middle East.

Earlier in the day, Suez Chief Executive Gerard Mestrallet confirmed that the possible sale of its environment unit, valued at nearly 20 billion euros, had been dragged into talks with the French state in the quest to rescue the merger agreement.

Mestrallet has repeatedly stated his opposition to a disposal but on Thursday appeared more cautious. He said it was not certain the group would accept the sale but gave no clear answer to questions on whether he still opposed it.

"That is part of the modalities which I will not talk about," Mestrallet told a news conference.

Pressed to say whether he had changed his mind on the issue, he said: "You cannot deduce that from what I have said."

With Suez shares now more than 5 euros above GDF's share price, analysts have said Suez will have to slim down by shedding its environment businesses, using the cash to pay a special dividend, if the original "merger of equals" is to be preserved.

Sarkozy said it was now up to Suez shareholders to decide whether or not the group would become an energy-only player.

"I proposed to Suez to merge its energy business with Gaz de France and build a great electricity and gas group... This implies that Suez make a strategic choice by specializing in energy," Sarkozy told a conference organized by French employer organization Medef outside of Paris.

STANDALONE STRATEGY

In another sign that the merger was in doubt, Mestrallet said Suez was prepared to go it alone if the deal failed, echoing similar comments from GDF on Wednesday.

"We are ready for two scenarios: going ahead with this project but also continuing our 'standalone dynamic' strategy in case the conditions for an agreement are not reached."

The merger was presented by a previous centre-right French government 18 months ago amid rumors of a bid for Suez by Italy's Enel (ENEI.MI).

Asked whether he feared Suez could become a takeover target again if the GDF deal fell through, Mestrallet said: "I objectively believe that big friendly takeovers are already difficult and that's even more true of hostile takeovers."

Gaz de France chief Jean-Francois Cirelli on Wednesday urged Suez to take "the necessary steps" for a merger. Both Suez and GDF have asked the European Commission to extend a Friday deadline for a merger deal as part of an approval process.

Suez also reported higher half-year operating profit, lifted by strong electricity prices and new water contracts.

Half-year current operating income of 2.79 billion euros was up from 2.38 billion in the first half of 2006, and in line with the 2.79 billion average forecast in a Reuters poll.

"Suez published a decent set of first-half results, which was slightly better than anticipated," said analyst Koen Dierckx at KBC Securities.