By Elvira Pollina and Paul Sandle
MILAN/LONDON (Reuters) - Vodafone (NASDAQ:VOD) will likely hold a minority stake in a combined entity with Swisscom\'s Italian unit Fastweb if a deal is reached on a potential tie-up of their Italian operations, three people familiar with the matter said.
Vodafone\'s Chief Executive Margherita Della Valle said earlier this month the British group was in \"active discussions\" in Italy, days after rebuffing a proposal by rival Iliad to create a 50:50 joint venture in the country.
Multiple sources have identified Swisscom\'s Fastweb as the other party in the talks.
The potential deal being discussed would see Vodafone take a minority stake in the combined entity, which would take its debt off Vodafone\'s balance sheet, said the people, who declined to be named because talks are not public and are ongoing.
Spokespeople for Vodafone and Swisscom declined to comment.
Operators in Italy are studying ways to consolidate a market grappling with shrinking revenue and margins, which is depriving investors of returns on their capital.
A deal with Fastweb would create Italy\'s second-largest fixed-line broadband operator with a strong presence in the prized business segment.
It would also face lower regulatory hurdles than a combination with Iliad but offers lower potential synergies, according to analysts.
Iliad, majority owned by French billionaire Xavier Niel, is continuing to push consolidation in Europe, and on Monday it unveiled an agreement to buy a 19.8% stake in Swedish telecoms operator Tele2 (ST:TEL2b) from investment company Kinnevik.
Italy is the final major market Vodafone wants to fix after it agreed last year to merge with Hutchison\'s Three in Britain and sell its struggling Spanish operation.
Della Valle, however, has said Italy is a very different market from Spain for Vodafone.
She said in November that Vodafone was outperforming its major competitors in Italy with its strong brand and network, but it was a very challenging market in which no player was delivering returns in excess of cost of capital.
Vodafone would probably not include in its accounts any entity in which it holds a stake of 50% or lower, which would take the new company\'s debt off its books but limit any control over its cash flows, meaning it could not rely on the income to fund its own shareholder returns.
Vodafone has already said it will review its capital allocation, including its dividend and any buyback, after the Spanish deal completes, expected in the first half of this year.
Della Valle told analysts this month that she still intended to update shareholders on its new capital allocation policy in May, regardless of the outcome of the Italian talks.