* PT stake in merged company cut to 25.6 pct from 38 pct in
* Portugal Telecom and Oi shares up in relief over tie-up
* PT to sue Espirito Santo company Rioforte to recover debt
* PT has option to buy back Oi shares if recovers money
* Still unclear on size of losses facing Banco Espirito
(Adds BES, PT closing prices, details on talks)
By Axel Bugge and Leila Abboud
LISBON, July 16 Portugal Telecom has
been forced to take a cut in its share of a merger with Brazil's
Grupo Oi after a holding company of the Espirito
Santo family failed to repay more than $1 billion it owed to the
Portugal's largest telecoms provider said it would take
legal action to try and recover the debt from the family
company, Rioforte, which fell due on Tuesday.
The revision of the terms of the merger with Oi is the most
high-profile consequence so far of the escalating troubles of
the Espirito Santo clan, once one of Europe's premier business
Senior representatives of key Oi shareholders, such as
Brazil's development bank BNDES and construction firm Andrade
Gutierrez, travelled to Lisbon and negotiated the
deal with PT's board on Tuesday, sources in Brazil said.
The Espirito Santo family's business empire is in disarray
since the emergence of accounting irregularities at another of
its holding companies, putting Portugal and the family-founded
bank Banco Espirito Santo (BES) under pressure as
questions swirl about potentially destabilising losses.
"From the point of view of reputation, this is bad for
Portugal's image as a whole, which was just beginning to improve
as the country exited the (EU/IMF) bailout," said Filipe Garcia,
head of Informacao de Mercados Financeiros consultants in Porto.
He said events raised question marks over management at BES
and the standards of governance at Portugal Telecom and its
failure to diversify risk.
The failure of Rioforte, which holds some of the family's
major assets, including hotels and property, to repay 847
million euros ($1.15 billion) in short-term debt owed to
Portugal Telecom by July 15 means the latter will now have a
25.6 percent stake in the merger with Oi instead of the 38
percent originally agreed.
The agreement also shifts the credit risk from the Rioforte
loans, which total 897 million euros, back to Portugal Telecom
and away from Oi, which has said it did not know about them.
The reworked deal reassured investors that the tie-up,
designed to create a telecoms champion with 100 million
subscribers and $19 billion in annual revenue, would go ahead.
It also shows that Oi will not go to war with its soon-to-be
partner despite threats from some of its shareholders to sue the
Portuguese carrier over the Rioforte loans. Brazil's state
development bank said the loan was inconsistent with "minimum
standards of good corporate governance".
"In our view, this deal is significantly positive for PT
investors and modestly positive for Oi investors, with it very
much in the interest of both parties to progress with the
merger," said Mark Chapman from Credit Insights.
Although the new merged company is likely to see its debt
downgraded to junk due to the unpaid loan, shares in Portugal
Telecom rose 3.3 percent to 1.89 euros in relief that the merger
will go through. They had slumped by more than a third to a
historic low in the past few weeks on concerns it would unravel.
Shares in Oi jumped the most in six months, rising over 13
Shares in BES soared to close almost 20 percent higher from
Tuesday's all-time lows on bargain-hunting and helped by reports
that its new chief executive may bring in new shareholders.
Also, Bank of Portugal chief Carlos Costa told TVI
television late on Tuesday that "if any additional capital were
needed due to risks that at this moment we do not see, certainly
there are shareholders interested in taking part in a BES
capital increase". He reiterated that BES was well capitalised.
Portugal's largest listed bank has said it has more than
enough reserves to deal with its exposure to the Espirito Santo
empire, but investors are still waiting for it to put a figure
on any losses.
Uncertainty over the eventual bill has triggered a plunge in
the bank's shares and bonds over the past month.
ALLIES NO MORE
Rioforte is the second Espirito Santo company not to honour
its debts in as many weeks, but the failure to repay the
Portugal Telecom loan cuts at the heart of the country's
tight-knit business community.
The Espirito Santo family and Portugal Telecom have a long
allegiance cemented by personal friendships and cross share
BES has a 10 percent stake in the telecoms group, and
Portugal Telecom officials knew the Espirito Santo clan had some
problems before they handed over the cash in April, people
familiar with the matter have told Reuters.
Portugal Telecom has declined to say why it invested so much
of its liquidity in one firm's commercial paper, and Oi has
sharply criticised the Lisbon-based group for not disclosing the
loan earlier. Oi's representatives had quit the Portugal Telecom
board in protest when told of the Rioforte deal.
Wednesday's agreement is likely to be seen as good news for
Zeinal Bava, Oi's CEO, who had headed Portugal Telecom's
Portuguese business before moving to Oi in June 2013, months
before the tie-up was announced.
Some investors had expressed concern that the Rioforte
situation would put Bava - whose operational know-how is crucial
to Oi - in a difficult position, since it remains unclear
whether he knew about the loan.
The unpaid debt, which had been transferred to Oi in May,
will now be shifted back to Portugal Telecom. Portugal Telecom
has a call option to buy back more shares in Oi over a six-year
period, potentially increasing its stake in the merged group if
it can recover some of the Rio Forte money.
The next step in the saga is expected to be Rioforte filing
for creditor protection, people close to the situation said on
Tuesday. There is a seven-day grace period on the loan that was
due on Tuesday before Rioforte is technically in
Portugal Telecom will then have to sue Rioforte to try to
claw back some of the money. Credit analysts said it was hard to
predict how long the process could take, but emphasized that PT
faced a difficult road to get paid back.
($1 = 0.7376 Euros)
(Additional reporting by Andrei Khalip, Guillermo
Parra-Bernal,; Writing by Carmel Crimmins; Editing by Tom
Pfeiffer, Will Waterman and Giles Elgood)