Telefónica, the Spanish telecoms group with a large presence in Europe and Latin America, has abandoned the idea of buying a minority stake in Telecom Italia and forming a strategic alliance.

Telefónica said last week that talks with TI were “on hold”, but people familiar with the Madrid-based group said it had hardened its position and was dropping the idea of buying a stake or establishing an alliance.

They said the decision had been made partly because the potential financial benefits of the alliance were not strong enough.

While in theory talks about an alliance could be revived in the future, they added that the idea had been abandoned for “the foreseeable future”.

Telefónica had been considering acquiring a 5.4 per cent stake in TI from Pirelli, the Italian tyres and real estate company that controls 18 per cent of TI’s shares and is looking to reduce its holding.

TI’s senior executives were on Tuesday finalising the group’s 2006 results and strategy plan up to the end of 2009, which will be presented to investors on Friday.

A previous strategy for a radical restructuring, which could have led to the sale of its mobile businesses in Italy and Brazil, was abandoned after the company ran into opposition from the Italian government.

The botched announcement of that restructuring last September led to the resignation of Marco Tronchetti Provera as TI’s chairman. Mr Tronchetti is chairman of Pirelli, which had been in talks with Telefónica in recent weeks about the Spanish group buying a stake in TI.

Telefónica had been considering buying a 30 per cent stake in Olimpia, the company through which Pirelli owns 18 per cent of TI. A 30 per cent stake in Olimpia would translate into 5.4 per cent of TI’s shares.

People familiar with the talks said Telefónica had been considering paying about €1.3bn, which would represent a premium of 25 per cent to the current price of TI’s shares.

Telefónica had been focused on the merits of an alliance with TI that would provide revenue and cost benefits. The combined purchasing power of the two groups, for example, might have led them to secure better deals on content for their fledgling internet television services.

However, people familiar with Telefónica said the benefits were not strong enough and noted how the markets had reacted negatively to the prospect.

They said Telefónica had wrongly been seen as having ambitions to secure control of TI and TIM Brazil, the Italian group’s Brazilian mobile business. Telefónica’s shares have fallen by more than 8 per cent since disclosure of its interest in forming an alliance with TI.

Pirelli has been in discussions with other companies about selling part of its TI stake, but bankers said the breakdown of the talks with Telefónica underlined the difficulties of reaching a deal.

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