MADRID/LONDON/MILAN (Reuters) - Spain's Telefonica is set to agree on an overhaul of Telecom Italia finances, including a likely cash injection of up to 2 billion euros, as it tightens its grip on the group and eyes a sale of its Brazilian unit TIM in 2014, multiple sources familiar with the strategy said.
Telecom Italia's board, controlled by Telco, an investment vehicle that Telefonica has agreed to progressively take over, is due to meet on Thursday to review cost-cutting, debt-reduction and growth strategies.
Apart from a possible capital increase of up to 2 billion euros ($2.7 billion), other options under consideration include sales of assets such as the group's mobile towers in Italy or its Argentinian unit, and a dividend cut, the sources said. No decision has yet been made on any of these.
Telefonica declined to comment, and Telecom Italia did not respond to a request for comment.
If the Spanish telecom operator, which bought into Telecom Italia six years ago when the local government sought a white knight to put off other foreign buyers, succeeds in getting approval to sell TIM Brasil, it will be a sign that it has gained the upper hand in the loss-making investment that has been a major headache in recent years.
A decision on the sale of TIM, which is the second-biggest mobile carrier in Brazil behind Telefonica's own Vivo, will not be made on Thursday, said the people familiar with the situation.
But in order to advance toward that end, the sources said Telefonica has no alternative to putting more money into Telecom Italia in order to buy time and prepare the TIM sale, although such a move is risky because the Spanish company is racing to reduce its own debt load.
TIM may have to be broken up between the existing mobile operators in Brazil instead of an outright sale to one of them because of the government's desire to prevent price rises. Brazil's government would have to sign off on the deal.
"A 1.5 billion euros to 2 billion euros cash boost through a convertible bond or a rights issue is on the cards. Selling Argentina is also a possibility," one person who discussed the matter with the Spanish group said on condition of anonymity, echoing the views of eight other people familiar with the matter.
"The end-game is to split TIM and sell it in chunks but that won't happen until at least the second half of next year. So they need to buy time," the person added.
The sources said Brazilian antitrust authorities were slowly being won over to the idea that TIM could be split between two or three operators, but a green light could still be several months away.
Telefonica will also want to have completed its purchase of German competitor E-Plus and the sale of its Irish and Czech units before moving forward with another major deal.
Other Brazilian players America Movil and OI, both potential buyers of TIM assets along with Telefonica's local unit, will also need six to nine months to put their houses in order and make such an investment, the sources said.
This leaves Telefonica in need of short-term solutions for the Italian group, which is battling to cut almost 29 billion euros of net debt.
Telefonica will have to tread a fine line between investing more into Telecom Italia to maintain its grip over it long enough to sell TIM while at the same time not consuming excessive financial firepower and staying clear from fully controlling the group, which would negatively impact its debt.
Insiders in Madrid, Milan and London say that Italian authorities are concerned Telefonica might exit Telecom Italia once the sale of the Brazilian crown jewel is completed.
In order to keep the Italian government on side, the Spanish group is being asked to show its commitment by taking up its part of a capital hike and supporting higher investment in fixed networks.
"Telecom Italia doesn't want to sell (TIM) although the goal of Telefonica is to force the sale. That might not come before 2015 as general elections in Brazil in October 2014 may make it politically difficult," Nomura analysts Frederic Boulan and James Britton told Reuters.
"At the same time, Telefonica needs to implement changes to convince co-investors in Telco to tag along as their exit window re-opens in June 2014... The challenge for Telefonica is to control or at least influence decisions at Telecom Italia but without consolidating it."
Telefonica Chairman Cesar Alierta last month offered assurances to Italian Prime Minister Enrico Letta over investments and employment but he gave no indication he was ready to inject more money into the company.
He may eventually have no other choice as the risk is high of a downgrade, which Telecom Italia cannot afford as a peak in debt maturities looms in 2014.
Standard and Poor's and Fitch credit rating agencies both rate Telecom Italia just one notch above junk status and have placed it under negative watch.
Moody's last month went one step further and stripped the group of its investment grade, with a negative outlook attached.
"In order for a capital increase to be material enough to reverse our decision it should be 4 billion euros to 5 billion euros... A 1 billion euros to 2 billion euros capital increase will not be sufficient to take positive action. The rating, even at the new level, is weakly positioned," Moody's analyst Carlos Winzer told Reuters.
"Remaining possibilities including the disposal of non-core assets and the implementation of a clear, more concise, focused operating strategy, will take time to implement... We have little confidence in the company achieving underlining performance targets." ($1 = 0.7421 euros)
Editing by Fiona Ortiz and Peter Graff