The sale of Italy's No.3 broadcaster Telecom Italia Media risks falling apart as potential bidders worry about the future of the industry and parent Telecom Italia considers a more radical sale project.

Private equity fund Clessidra, Hutchison Whampoa's <0013.HK> Italian telecom operator, U.S. TV group Discovery Communications and advertising firm Cairo Communication are circling and have until November 19 to submit binding offers.

But poor advertising sales and rising competition in Italy's TV market mean the sale is not straightforward.

"A TV business in a G8 country is certainly valuable. But there are clear risks of offers below market value," a person familiar with the bidding process told Reuters.

"I see a 50 percent probability of the deal happening."

Loss-making Telecom Italia Media suffered for years from the dominance of former prime minister Silvio Berlusconi's Mediaset empire and a lack of interest from major advertisers, making owner Telecom Italia reluctant to invest in the business.

Now however, Berlusconi's media empire is struggling against rivals like News Corp's broadcaster Sky Italia and a host of online media, meaning Telecom Italia Media could provide an 'in' for a buyer looking for a foothold in Italy.

That said, the country's advertising market is forecast to drop 10 percent this year and 2 percent next. Any buyer with pockets deep enough to withstand that may also have to face increased competition from the sale, repeatedly delayed, of new TV licenses.

The uncertainty is likely to show in buyers' proposed offers, which could disappoint debt-laden Telecom Italia. The parent company values its 77 percent stake at 176 million euros. Telecom Italia Media's market value is 270 million euros - the shares have gained 29 percent on bid talk over the last six months - and the unit has net debt of 200 million euros.

Telecom Italia Chief Executive Marco Patuano said last week his group, which has debt of 30 billion euros, still expected to sell the TV unit by the end of the year.

A sale would fetch welcome cash for Telecom Italia, which is seeking to win back investor confidence. Its shares are down 10 percent this year. The sector index is down 4.5 percent.

"That this was not going to be an easy sale was clear from the beginning. But the sale is moving forward, step by step," a financial source with knowledge of the bidding told Reuters.

But Telecom Italia is also considering a spin-off of its valuable landline infrastructure, valued at 9-15 billion euros, as the former state-owned phone monopoly comes under pressure from Rome to modernize Italy's creaking broadband network.

If Telecom Italia moves ahead with such a complex transaction, its interest in selling the media unit could fade, analysts and observers say.

Telecom Italia Chairman Franco Bernabe said in September the company would not sell its TV arm at any price, adding that the buyer's industrial plan would be important too. He said a spin-off of the network would be done purely for industrial reasons.

Mediobanca and Citigroup are advising the company on the sale of Telecom Italia Media.

CARVE UP?

Telecom Italia is open to bids for its whole media entity but will also consider selling the cash-burning TV channels separately from the profitable broadcast network operator.

Flagship La7 channel holds the key to Telecom Italia Media's potential. Audience share peaked at 3.9 percent in 2011 thanks to popular local anchors - some poached from Mediaset and state-TV RAI - and incisive talk shows contrasting with traditional political debates or shows featuring bikini-clad models.

But La7 faces a key regulatory decision in the next six months over whether it can keep its convenient single-digit position on the TV zapper. Marketing studies show that Italian TV audiences tend to stick to the lower channels on the dial, and moving to a double-digit position could hurt ad sales.

"Losing the seven position on the dial would be a fatal shot," the person familiar with the bidding said.

Telecom Italia Media's broadcast network operator, which leases digital bandwidth to carry its own channels and a dozen others, generates cash and has had a core profit margin between 35 and 57 percent since 2008. The frequency now leased to TV channels could also be converted to carry telecom traffic after 2016 if regulators support the move, experts say.

The four suitors are very different animals.

Clessidra, Italy's largest private equity house, is the only one bidding for both assets. But the fund values Telecom Italia Media at 330-380 million euros, including debt, a source said - meaning Telecom Italia looks unlikely to make a capital gain.

"Part of Telecom Italia's board is very keen on selling the unit. If bids are not too damaging to its balance sheet they might decide to swallow an offer below book value," an M&A advisor said.

Ad group Cairo Communications has a lucrative contract to sell ad space on Telecom Italia Media's TV channels through 2019. Buying the company would help it boost profits.

Italy's smallest mobile operator, Hutchison is more attracted by the network operator business, while Discovery wants the TV channels to build its existing activity in Italy.

Splitting up the company could raise a problem of parceling out debt, as creditors would prefer debt to be allocated on the profitable part of the business.

Telecom Italia must also be sure not to weaken its core business if it sells to a competitor such as Hutchison. But a sale to Discovery, instead, could upset Berlusconi's Mediaset by strengthening its competitor.

Observers have speculated that Clessidra and Cairo, both run by men who have worked for Berlusconi in the past, could minimize competition for the media mogul.

"It's a problem if the unit goes to the wrong buyer," said Robin Bienenstock, analyst at Sanford Bernstein Research.

"The sale is horribly political but Telecom Italia doesn't really need to sell and I don't think they will."

(Editing by Sophie Walker)