By Danilo Masoni and Julien Toyer
MILAN/MADRID, July 17 (Reuters) - Telefonica's move to reduce its stake in Italian rival Telecom Italia may help the Spanish phone group appease regulators over competition concerns in Brazil and possibly accelerate consolidation in that market.
Telefonica controls Vivo, Brazil's leading mobile operator, and is the biggest shareholder in Telecom Italia , which owns Vivo's rival TIM Participacoes.
Brazil is a crucial market for Telefonica because it is its second-biggest generator of cash after its home market, and still has growth opportunities unlike relatively saturated European markets like Germany and Britain.
Brazilian watchdog CADE gave Telefonica 18 months to either sell its interest in Telecom Italia, or seek a new partner for Vivo in December following a deal with Italian investors which gave Telefonica nearly 15 percent of Telecom Italia.
On Thursday Telefonica launched the sale of a 750 million euro ($1 billion) bond exchangeable into Telecom Italia shares, reducing its stake to between 9.4 and 8.3 percent on conversion and loosening its grip as the group's largest shareholder.
It also sought to appease the Brazilian regulators by pulling its two representatives from Telecom Italia's board back in December to avoid conflicts of interest.
But it is the decision to partially exit its investment in Telecom Italia that has fuelled expectations the regulator might now soften its stance towards the Spanish group, people familiar with the situation and analysts said.
"I don't imagine CADE will look at this negatively, on the contrary," a senior Brazilian telecoms executive told Reuters.
Telefonica declined to comment while CADE said it had not officially been informed of the plan and so could not comment.
The exchangeable bonds, which allow Telefonica to protect itself from downside risk whilst also benefiting from any upside in Telecom Italia's share price, mature in three years but can be converted at any time before that or paid in cash if conditions are met.
Banca Akros analyst Andrea De Vita said a reduction of Telefonica's stake in Telecom Italia to below 10 percent may be enough to alleviate Brazil's concerns.
It may also pave the way for speedier consolidation.
Telefonica's aim is to break up TIM Participacoes and share its assets with other local players America Movil and Oi to eliminate its rival, sources close to the matter have said. To do that, Telefonica - or one of the other players such as Oi - would have to undertake a joint bid for TIM and secure approval from regulators who could have qualms about such a plan if they believed Telefonica's conflict of interest was still in place.
Telecom Italia is in favour of keeping its stake in the Brazilian unit because it accounts for one third of its sales, but it does not rule out a sale, Chairman Giuseppe Recchi said earlier this month.
Other Telecom Italia investors including businessman Marco Fossati, who owns a nearly 5 percent stake, oppose the break-up plan and see more value for Telecom Italia in a merger between TIM Participacoes and local broadband operator GVT, a unit of France's Vivendi.
"The market is clearly betting on a consolidation of the Brazilian market and while there are many conditions still to be met for that to happen, yesterday's move clears one hurdle," said one source familiar with Telefonica's thinking.
(Additional reporting by Leila Abboud in Paris and Leonardo Goy in Brasilia; Editing by Elaine Hardcastle)