By Guillermo Parra-Bernal, Tatiana Bautzer and Leonardo Goy
SAO PAULO/BRASILIA (Reuters) - Oi SA (SA:OIBR3), Brazil's most indebted phone carrier, has started talks with the controlling shareholder of rival TIM Participações SA over a potential merger, with discussions initially focusing on governance issues, two sources with direct knowledge of the matter said on Thursday.
The board of Telecom Italia SpA (MI:TLIT), which controls TIM (SA:TIMP3), and Oi Chief Executive Officer Bayard Gontijo are leading the talks, which are also centering on possible changes in Brazilian telecommunications industry rules that could favor the tie-up, said the sources, who requested anonymity to discuss the issue freely.
Oi is seeking a merger because it lags its three major rivals in Brazil's fiercely competitive wireless market, with 18 percent of subscribers. Gontijo has streamlined operations, cutting everything from payroll to air conditioning and selling a Portuguese unit to cut the company's 35 billion reais ($8.7 billion) in debt.
In contrast, Telecom Italia has remained wary of selling or merging TIM, which it calls a strategic asset and contributes a third of its revenue.
None of the sources said when the discussions between Telecom Italia's board and Oi began. The talks could establish the basis for a final proposal to merge TIM and Oi, but have not discussed the value of a possible deal, the two sources added.
A third and a fourth source said that Oi's adviser on the process, Grupo BTG Pactual SA, could present a merger proposal for both companies before the end of January. The plan would entail the participation of billionaire Mikhail Fridman's LetterOne Holdings, through a $4 billion cash injection into Oi, the same sources said.
Whereas Oi and BTG Pactual (SA:BBTG11) want LetterOne to become a shareholder of the combined entity, Telecom Italia does not see the investment firm's involvement in the deal as necessary, the first source said. LetterOne has a seven-month exclusivity period for the Oi-TIM deal that expires in May.
Telecom Italia, Oi, BTG Pactual and LetterOne declined to comment.
Oi's nationwide fixed-line network, the country's largest, would complement that of No. 2 wireless carrier TIM, according to analysts.
Together they would operate 44 percent of mobile lines in the country, well ahead of current market leader Telefonica (MC:TEF) Brasil SA (SA:VIVT4) and the local unit of America Movil SAB (MX:AMXL), which have 29 percent and 25 percent of the market, respectively.
Oi is the world's worst-performing telecoms stock over the past six months, according to the Thomson Reuters Global Telecoms Services index – down 67 percent.
'APPEALING'
The preliminary discussions underscore optimism among the companies over a long-sought revamping of industry rules, the sources noted. In October, both Gontijo and Telecom Italia CEO Marco Patuano said any potential consolidation effort in Brazil's telecommunications industry would hinge on a more flexible regulation of carriers.
Industry watchdog Anatel put a draft document enacting some of those changes up for public hearings that are slated to end on Jan. 15. Some of the issues that could favor a TIM-Oi combination encompass the easing of mandatory investments in fixed-line telephony, an issue that still has some government officials at odds, according to a fifth source.
Reuters reported in October that industry watchdog Anatel is leaning toward easing some rules imposing onerous fixed-line investments in a segment in which revenue per user is declining dramatically.
"The removal of those mandatory investments would significantly make Oi more appealing to TIM, and make a deal feasible," said the third source.
Oi has for years spent heavily to cope with mandatory fixed-line expansion goals, hampering its ability to compete in the mobile and data segments.
Bank of America Merrill Lynch (N:BAC) and Banco Bradesco BBI are working as Telecom Italia's and TIM's advisers on the deal. Oi and BTG Pactual may hire two banks that could have both adviser and lending roles, the second source added.
($1 = 4.0434 Brazilian reais)