* Plan was dropped just before announcement -sources
* Plan still faced legal, shareholder challenges -sources
* RWE was seeking clean power, stronger earnings -source
* Iberdrola, RWE decline to comment
By Peter Dinkloh and Arno Schuetze
FRANKFURT, May 6 (Reuters) - Germany's RWE (RWEG.DE) and Iberdrola (IBE.MC) came close to announcing a 60 billion-euro
($87 billion) combination in February but the Spanish utility pulled out of talks, sources familiar with the matter said.
The talks between Europe's fifth- and sixth-largest utilities were abandoned just before the companies planned to announce them, two of the sources, who are close to the companies, told Reuters.
"The talks were serious and rather advanced," said a person from the finance industry with knowledge of the talks.
"But Iberdrola dropped out of the talks as it would have obtained only a rather small advantage for the price of getting together with a company in a difficult business situation," the person added.
Legal and shareholder issues remained unresolved, including whether local communities in western Germany, which hold a blocking minority in RWE, could be persuaded to accept a deal, said two people.
Officials at Iberdrola and RWE both declined to comment. Iberdrola's chief executive, Ignacio Sanchez Galan, on Wednesday ruled out acquisitions in the short term.
The Spanish utility, based in Bilbao in the Basque country, is seeking to prevent 20 percent shareholder ACS (ACS.MC) from increasing its control. A combination with RWE could have reduced the ACS stake by half, said one source. [ID:nLDE7331Y7]
But a deal with RWE would mean joining forces with a company that faces three years of falling profits and that -- according to unconfirmed reports -- has already held talks with Czech utility CEZ CEZPsp.PR and French power company EDF (EDF.PA). [ID:nLDE71M265]
RWE, which has its headquarters in Essen, close to Germany's Dutch border, is Europe's largest polluter and is struggling to get to grips with its emissions before it has to buy certificates allowing it to emit carbon dioxide from 2013 onwards.
It is shedding assets worth 8 billion euros to defend its current credit rating, which has been hit by concerns over regulation of nuclear power in Germany and power prices that are a quarter below their heights in 2008.
The talks involved combining the two groups under the roof of a newly created company that would be based in The Netherlands and offer shares to the utilities' existing shareholders, two people with knowledge of the talks said.
Iberdrola has higher profit margins than RWE, giving it a value of 36 billion euros on the stock market, a third more than RWE, according to Reuters data.
But the business of the German company is still larger than that of the Spanish competitor. RWE earned 10.3 billion euros before interest, taxes, depreciation and amortisation in 2010, 3 billion more than Iberdrola.
(Additional reporting by Jonathan Gleave and Carlos Ruano in Madrid and Philipp Halstrick in Frankfurt; Editing by Alexander Smith)
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