2nd UPDATE: Portugal Vetoes PT Vivo Stake Sale To Telefonica

The Portuguese government Wednesday vetoed a EUR7.15 billion bid from Spain's Telefonica SA (TEF) to buy out Portugal Telecom SGPS S/A (PT) from the two companies' Brazilian joint venture in a surprise move that sets the stage for a confrontation with European Union authorities.

Portuguese Prime Minister Jose Socrates defended his decision to use Portugal's golden share to veto the deal, saying the country has a strategic interest in maintaining the size of its largest company by market value. "The offer was not in the interest of PT," Socrates told Portuguese television. "The government is protecting the interests of the country."

PT and Telefonica have been locked in a power struggle over Brazilian mobile operator Vivo, which the two Iberian telecoms control through a joint venture that owns 60% of the company.

Both PT and Telefonica see Vivo as key to their future growth prospects as they face declining revenue in their mature home markets and are suffering the lingering impact of a severe recession. They are increasingly dependent on emerging economies like Brazil, where a young population and low mobile penetration rates makes it easier to pick up new wireless and Internet customers. Brazil has about 183 million cellphone accounts, and Vivo is the market leader with a market share of 30%.

Telefonica late Tuesday raised its offer for PT's indirect stake in Vivo for the second time. The Spanish company's initial bid of EUR5.7 billion was swiftly rejected by PT's board last month. It then raised the offer to EUR6.5 billion.

The government's veto comes ahead of an expected ruling by the European Court of Justice next week on the legality of Portugal's golden share in PT, which is designed to prevent a hostile takeover.

European authorities claim Portugal's ownership of such a golden share breaches the principle of the free movement of capital.

About 74% of PT shareholders voted in favor of the Spanish company's offer at PT's extraordinary general meeting. A Telefonica spokeswoman declined to comment on what the government's veto will mean for Telefonica's strategy.

"We have to study the decision first," the spokeswoman added.

PT Chairman Henrique Granadeiro said Wednesday the company's directors didn't think the government's golden share could be used in this way.

"The board has repeatedly said that it was convinced the golden share wasn't applicable in this situation," Granadeiro told journalists after the extraordinary meeting. The decision is based on legal interpretations "and we respect the decision," he added.

-By Jeffrey T. Lewis, Santiago Perez and Jonathan House; Dow Jones Newswires; djmadrid@dowjones.com; 34 91 395 8120

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