5th UPDATE: Portugal Vetoes PT Vivo Stake Sale To Telefonica

The Portuguese government Wednesday vetoed an EUR7.15 billion bid from Spain's Telefonica SA (TEF, TEF.MC) to buy out Portugal Telecom SGPS SA (PT, PTC.LB) 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 Participacoes SA (VIV, VIVO4.BR), which the two Iberian telecommunications companies 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.

"This outcome is simply horrible for everyone and the only likely thing from here is litigation," Bernstein Research analyst Robin Bienenstock said in a note to investors. "We would also caution that we think that Telefonica has now seriously overpaid for this asset and that this price is a reflection of their domestic weakness."

Telefonica late Tuesday raised its offer for PT's indirect stake in Vivo for the second time, in a last-ditch attempt to win over PT shareholders reluctant to exit the coveted Brazilian market. 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 and finally to EUR7.15 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.

Telefonica said in a press release that the decision from the Portuguese government and the use of its so-called golden share in PT was illegal and in violation of regulations in Portugal and the EU.

Telefonica also said it's extending the acceptance period of its bid to July 16.

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.

In a late press release, PT said its board of directors, which met after the company's EGM, has agreed to seek legal clarification on the government's decision to veto the sale of its Vivo stake.

The board "has considered that there are some legal matters that require clarification and, as a result, will be obtaining legal opinions," PT said.

Once the company gets such legal elucidation, it will schedule a new board meeting, it added.

There is a good chance that Telefonica "will be able to table [present] the offer again if the golden share is ruled illegal," said ING analyst Georgios Ierodiaconou.

PT shares dropped sharply after a trade halt was lifted following the shareholders meeting, falling almost 6% to EUR7.88. Telefonica shares, in turn, were down 0.1% to EUR15.10 at 1430 GMT. PT's American depositary shares closed down 1.1% at $9.92, while Telefonica's edged up 0.6% to $55.53.

Both Iberian telecommunications companies are increasingly dependent on emerging economies like Brazil, where a young population and low mobile penetration rate 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%. But rivals are close behind; Claro--the local unit of Carlos Slim's America Movil SA (AMX, AMX.MX)--Oi, and Telecom Italia SpA's (TI, TIT.MI) TIM Participacoes (TSU, TCSL4.BR) are all moving to offer combined fixed-line, Internet, television and cellphone services to extend their grip on the market.

-By Jeffrey T. Lewis, Santiago Perez and Jonathan House; Dow Jones Newswires; enza.tedesco@dowjones.com

(Enza Tedesco contributed to this article.)

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