* PT loaned its cash to BES group company Rioforte in April
* Sources say PT executives already knew of family's
* Rioforte may not be able to repay at Tuesday deadline
* Default risks hurting PT's planned merger with Brazil's Oi
* PT shares down 30 pct this month to historic lows
By Sergio Goncalves and Leila Abboud
LISBON/PARIS, July 13 Investors in Portugal
Telecom, and notably its Brazilian merger partner Grupo Oi,
should know by Tuesday whether more than $1 billion it lent in
April to a vehicle of the troubled Espirito Santo family is
being repaid on time.
Fears of a default by holding company Rioforte have already
angered the Brazilians, who say they did not know of the loan.
But a revelation that executives at Portugal Telecom, in which
the family has a significant stake, knew the Espirito Santos had
problems before handing over the cash could raise new questions.
The loan of 897 million euros in 3-month commercial paper
maturing this week were agreed by PT managers at a meeting in
April, people familiar with the discussion told Reuters. Though
problems at Rioforte's owner were made public only in May, they
said PT officials already knew it was facing some difficulties.
They still transferred the funds, which PT had been holding
in cash or short-term instruments linked to bank accounts, those
people added. On June 30, PT said the two issues of 3-month
commercial paper paid an average annual return of 3.6 percent.
Portugal Telecom declined comment on whether its officials
knew of the difficulties at Espirito Santo International or on
why it bought commercial paper from Rioforte, 100-percent owned
by ESI and the owner of assets ranging from hotels to tropical
plantations. The investment was equivalent to 38 percent of the
cash and equivalent investments that PT reported at end-March.
Rioforte has not commented on its repayment plans. It is due
to repay 847 million euros on Tuesday and 50 million on Thursday
to PT, in which family-founded Banco Espirito Santo has a
10-percent stake. BES is in turn indirectly part-owned by
Rioforte and has said it may face losses on its exposure to the
There was no immediate comment from Grupo Oi. It has sharply
criticised PT for not disclosing earlier a loan deal that has
embroiled the merger in turmoil at the Espirito Santo group and
at BES, Portugal's biggest listed bank, that has shaken investor
confidence in the country and ruffled stock markets worldwide.
The Brazilian phone company agreed in October to a merger
giving PT shareholders 38 percent of the new group. It may seek
to rework those terms as fears of exposure to the Espirito Santo
empire has helped wipe a third off the value of PT's stock,
driving the phone company's market value to 1.6 billion euros.
Bankers working on the merger, major shareholders in the two
firms and sources close to the Brazilian government do not
expect the deal to fall through, however, as neither side would
benefit and unwinding it would be difficult.
On the loan to Rioforte, PT might extend or restructure the
debt to ensure that it recovers at least part of the funds,
credit analysts and investors following the situation said.
But Oi could push for a change in the merger terms to
reflect PT's lower value if it loses the Rioforte cash.
Under the original terms, PT's equity value was 1.9-2.1
billion euros, and PT was to end up with 38 percent of the new
company. That could fall to as little as 20 percent if its
valuation were revised to reflect a loss of the cash, according
to credit analysts and investors speaking to the company.
Beyond the financial loss, the Rioforte loan risks poisoning
relations between PT and Oi managements ahead of a union
intended to make both firms stronger by creating a carrier with
100 million subscribers and $19 billion in annual revenue.
Oi has vowed to protect its interests. Its representatives
quit the PT board in protest when told of the Rioforte deal.
Brazil's state development bank called the loan inconsistent
with "minimum standards of good corporate governance".
On June 30, Portugal Telecom said of the deal: "Treasury
operations are carried out in the context of analysis of various
short-term investment options available in the market and taking
into account the attractiveness of the remuneration offered and
are monitored and approved by the Executive Committee."
Company records show Chairman Henrique Granadeiro and Chief
Financial Officer Luis Pacheco de Melo are on the executive
committee. A 3.6-percent return compares to under 0.5 percent on
Portuguese government 3-month bills. European Central Bank data
indicates returns around 2 percent are typical on three-month
euros lent to major European banks and commercial borrowers.
Portugal Telecom has not said why it invested so much of its
liquidity in one firm's commercial paper instead of keeping cash
in banks, an option that carries a much lower risk of default.
Firms typically opt to keep a limited portion of their excess
cash in commercial paper because it offers a higher return.
PT, which owns 2.1 percent of Banco Espirito Santo, said in
its June 30 statement its investment was based on a 14-year-old
"strategic partnership" under which PT provided communications
services to BES and the bank was preferred provider of financial
services to PT. According to a person involved in the family
holdings, PT has invested before in Espirito Santo companies.
Portugal Telecom had been investing in the debt of Rioforte
owner Espirito Santo International for more than a year, that
person said. On May 21, BES disclosed a "serious financial
condition" at Luxembourg-based ESI. Luxembourg's regulator has
launched a probe into the Espirito Santo family holdings.
The tie-up between Portugal Telecom and Oi is part of a
broader push by phone companies to bulk up via a wave of
consolidation in Europe and the United States.
For both companies the deal was aimed at resolving specific
weaknesses: Oi's big debts have thwarted its ability to invest
in its network; PT had a small and sluggish home market.
An official from one of the 10 biggest shareholders in
Portugal Telecom told Reuters that the company was working hard
to resolve the Rioforte problem and safeguard the merger:
"Calling the merger off doesn't help anybody and it would be
technically very difficult to do," the investor said.
"I hope that common sense will prevail."
(Additional reporting by Axel Bugge, Guillermo Parra-Bernal in
Sao Paulo; Editing by Alastair Macdonald)