The Italian government is in in talks with Telecom Italia Spa about the phone company’s strategic options, including a possible takeover by Spain’s Telefonica SA, said a person familiar with the situation.

The discussions, involving the Italian treasury, are at an early stage, said the person, who declined to be identified because the talks are private. The future ownership of Telecom Italia’s fixed-line network, which the government wants to keep in local hands for national security reasons, is among the issues under discussion, the person said.

Telecom Italia surged the most in almost a year in Milan yesterday after la Repubblica reported that the Italian government supports an “inevitable” merger. A combination would let Telecom Italia cut debt of about 35 billion euros ($49 billion) and give Telefonica, which already owns a stake in the Italian company, a larger presence in Europe and Latin America.

“Sooner or later there is going to be a deal,” said Carlo Luoni, a fund manager at 8A+ Sgr SpA in Varese, Italy. “With Telefonica, there would be the opportunity to make investments that Telecom Italia can’t afford now because of its debt burden.”

Other bidders for Telecom Italia could also emerge, said the person. Telefonica joined a group of Italian investors in 2007 to acquire a controlling stake in Telecom Italia for 4.1 billion euros, beating Mexican billionaire Carlos Slim. Telefonica is the largest shareholder of Telco SpA, an entity controlling Telecom Italia with a 22.4 percent stake.

Spokesmen for the Italian treasury and Telefonica declined to comment, as did a spokeswoman for Telecom Italia.

Strategic Asset

Telecom Italia climbed 6 percent yesterday to 1.146 euros, the biggest gain since Feb. 26, 2009. Telefonica rose 0.6 percent to 17.42 euros in Madrid.

Repubblica said yesterday that Prime Minister Silvio Berlusconi will “give the go-ahead to a share-based offer” the Madrid-based company plans to make in a “short time.” The prime minister’s office denies the report “in the most categorical manner,” it said in an e-mailed statement.

Berlusconi’s office said it had had no contacts or meetings with Telecom Italia on a merger with Telefonica, and “has set no conditions” on a deal.

It’s customary in Italy for companies that are considered strategic to seek government approval for cross-border transactions.

“A full merger between the two companies would have immense industrial value and generate significant synergies,” Marco Fossati, whose family company Findim Group SA owns about 5 percent of Telecom Italia and is its second-biggest shareholder after Telco, said in an interview last week. “I believe so much in the integration that I would be willing to take Telefonica shares in a deal.”

Source:Bloomberg