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Saudi Telecom Company and its closest competitor Mobily could sell a large stake in a combined $2.5 billion merged towers business, three people familiar with the matter said on Wednesday.

Market leader and state-owned STC operates around 11,000 towers, and number two operator Mobily, 26 percent owned by the UAE's Etisalat, has about 3,500.

Analysts have said telecom companies typically spin off tower holdings into an independent firm, which makes it easier to attract rival carriers as tenants and boost the earnings potential of the business.

"Talks for the merger are on, but this is subject to negotiations and terms and conditions put forth by both companies," one of the people said.

Other people had said previously that Saudi Telecom was looking to sell a stake in its tower business on its own, to cut costs as its market share came under pressure from Mobily and number three company Zain Saudi.

"There is still a long way to go before a deal happens between STC and Mobily," said Dubai-based Credit Suisse analyst Richard Barker. "If a deal were to happen eventually, it could be material and deliver substantial cost savings."

The two companies are considering selling a large stake in the combined tower company if the merger goes ahead.

"Mobily and Saudi Telecom are not likely to sell more than 51 percent in the new telecom infrastructure firm (the joint company)," the first person said.

But a second person cautioned that the Saudi companies were still deciding whether to sell 49 percent or 51 percent.

India's largest independent tower company GTL Infrastructure, which has 32,463 towers, could bid for the stake with Abu Dhabi investment fund Mubadala, the people said.

Swedish company Ericsson is lined up to bid alongside Saudi private equity firm Abraaj Capital and SREI Infrastructure, the parent of Indian group Quippo, could form a third bidding team with Zamil Group, they said.

Mobily declined to comment, while STC could not be reached for comment.

HURDLES

But Saudi Arabian regulators might be sensitive to a deal whereby the country's two largest telecom companies would combine their towers -- used to transmit wireless signals -- and squeeze smaller players such as Zain Saudi.

"I suspect there is a real possibility that the regulators would insist that any such deal involved Zain," said Credit Suisse's Barker.

"They would want the third player to remain viable and to keep a level playing field. Exclusion from such a deal would be bad news for Zain," he said.

Zain Saudi -- 25 percent of which is being sold as part of another deal -- said in January it was in talks with lenders after missing some commitments on a two-year $2.5 billion Islamic loan.

The sale of the stake in Zain Saudi is a regulatory condition for Etisalat's purchase of a 46 percent holding in Kuwait's Zain, imposed by the Saudi Arabian regulators.

Kingdom Holding 4280.SE, Saudi prince Talal bin Alwaleed's investment firm, has made a non-binding offer to buy the wider Zain Group's 25 percent stake in Zain Saudi.

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