SAO PAULO/BRASILIA (Reuters) - Oi SA , Brazil's most indebted phone carrier, has started talks with the controlling shareholder of rival TIM Participações SA over a 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 , which controls TIM , 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 a tie-up, said the sources, who requested anonymity to discuss the issue freely.Oi is seeking a merger because it lags behind 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 net debt.In contrast, Telecom Italia has remained wary of selling or merging TIM, a strategic asset that contributes about a third of its revenue. A merger between the two would create Brazil's No. 1 wireless carrier and relieve pressure in a crowded market suffering from the nation's worst recession in a quarter century.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, although the value of a possible deal has not been discussed, 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 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.Fridman, who made a fortune in Russia after the Soviet Union collapsed in 1991, has been actively investing in a number of industries recently, from telecommunications to energy. LetterOne oversaw $25 billion at the start of last year.Telecom Italia, Oi, BTG Pactual and LetterOne declined to comment.SHARESOi'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 Brasil SA and the local unit of America Movil SAB , which have 29 percent and 25 percent of the market, respectively.Shares of Oi are the world's worst-performing telecommunications stock over the past six months, down 67 percent, according to the Thomson Reuters Global Telecoms Services index. Voting shares of Oi rose 3.7 percent on Thursday in São Paulo to 2.55 reais. American depositary receipts of the Rio de Janeiro-based company shed 8 percent in New York to close at $0.39. '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 and Banco Bradesco BBI are working as Telecom Italia's and TIM's advisers on the deal. Oi may hire two banks that could have both adviser and lending roles, the second source added.($1 = 4.0434 Brazilian reais) (Additional reporting by Luciana Bruno in Rio de Janeiro and Stefano Rebaudo in Milan; Editing by Bernard Orr and Andrew Hay)
