UPDATE 2-Telefonica says has other options for O2 if sale is blocked

* Telefonica says could sell, merge, list O2 if sale blocked

* Says it could also decide to build up British operations

* Underlying sales rise, revenues grow in Spain

* But core profit fall on Latin American currencies

* Shares fall 4.2 percent (Recasts with chairman and CFO comments, new comments)

By Julien Toyer and Andrés González

MADRID, April 29 (Reuters) - Spain’s Telefonica said on Friday it had plenty of options for its British O2 subsidiary if EU competition regulators block its sale to CK Hutchison Holdings.

The EU antitrust watchdog is due to decide by May 19 on whether the deal would harm competition and sources told Reuters on Monday it was likely to be blocked, a risk Telefonica’s new chairman Jose Maria Alvarez-Pallete acknowledged at the company’s first quarter results.

He said that if the sale was vetoed the firm could partially or totally sell, merge or list O2. It could also invest in it to build a convergent player able to offer bundled packages of mobile and fixed line phone, internet and television services.

As it tries to cut its debt level, Telefonica could also issue hybrid bonds but it ruled out both a fire sale of O2 and any measure that would dilute shareholders such as a capital increase.

It was also not planning to save cash for debt reduction by changing its policy of paying shareholders a 0.75 euro per share dividend against 2016 earnings, Alvarez-Pallete said.

Shares in Telefonica lost 4.253 percent to 9.522 on Friday, erasing strong gains from the last three days as investors priced in the likelihood that the deal would be blocked. The blue-chip index Ibex was down 2.62 percent.

“Our concerns about the overestimation of prospects in Spain, especially at a cash level, the unsustainability of the dividend and a higher risk of downwards estimate revision than upwards, are all confirmed. Moreover, the possibility of the EU blocking the O2 deal seems to grow day after day,” said Mirabaud analyst Javier Mielgo in a note.

Telefonica has committed to bringing its leverage ratio down to 2.35 times operating income before depreciation and amortisation (OIBDA) and the O2 sale would contribute 10.3 billion pounds ($15 billion) to that effort.

At the end of March, the group’s leverage ratio was 3.02 times Oibda while net debt stood at 50.2 billion euros, up from 49.9 billion euros at the end of December, a level which Chief Financial Officer Angel Vila said was not worrying.

“Our liquidity is very high, the cost of debt service is at historic minimums, Oibda is growing... and that allows us to look at debt service in a way that is not a concern, but we have a commitment to our rating and we are going to be working in this direction”,” Vila said.

Although Oibda dropped by 6.7 percent in the first quarter to 3.376 billion euros ($3.85 billion), underlying revenues and core profits were up and broadly in line with forecasts.

Underlying revenues rose by 3.4 percent to 10.784 billion euros as activity in Spain picked up, while Oibda would have increased by 5.5 percent if it had not been for depreciating Latin American currencies.

Margins were also stable year-on-year, with a 3 percentage point increase in Brazil making up for a 4 percentage point fall in Spain, where Telefonica continued to offer discounts on its main television packages in a bid to increase its customer base. ($1 = 0.8776 euros) (Reporting by Julien Toyer; Editing by Greg Mahlich and Elaine Hardcastle)