(Adds comments by former communications minister and industry source, adds share price)
By Brad Haynes and Guillermo Parra-Bernal
SAO PAULO, Sept 23 (Reuters) - Grupo Oi SA, Brazil's most indebted telecom company, backed out of a key auction for fourth-generation (4G) cell spectrum on Tuesday, adding to speculation of an upcoming takeover in a highly competitive wireless market.
Any Brazilian wireless carrier left out of the auction this month will likely face merger pressure from other players, the superintendent of competition at telecom regulator Anatel told Reuters in July.
Speculation has swirled this year over possible mergers in Brazil's cooling telecom market, where stiff competition and expensive investments in new technology are hurting profit.
"Oi is positioning itself for a consolidation of the market. That is going to happen and this decision is clearly related," said an industry source who asked not to be named because of the strategic sensitivity of the issue.
Oi's decision means only three of an existing four major cellphone carriers will have nationwide 4G coverage on the most cost-effective bandwidth.
The auction scheduled for Sept. 30 will focus on bandwidth in the 700 MHz range, which offers up to four times the coverage per tower of the 2.5 GHz spectrum auctioned in 2012. Rivals Telefonica Brasil SA, TIM Participações SA and the Claro unit of Mexico's America Movil SAB de CV handed in their sealed bids on Tuesday.
Oi said it had sufficient bandwidth in the 2.5 GHz range to meet clients' 4G needs until 2017, adding that it could use bandwidth in the 1.8 GHz range in the future. The company declined to comment on rumors of an upcoming merger.
Oi hired Brazilian investment bank BTG Pactual last month to explore a possible joint bid for TIM with America Movil, which also expressed interest.
BTG is also looking to include Telefonica in a joint bid, according to the industry source. The Spanish rival has been focused on its takeover of local broadband operator GVT and declined to comment on any potential talks with Oi.
Oi's 46 billion reais ($19 billion) of debt has limited its maneuvering room, adding to speculation that TIM's parent company, Telecom Italia SpA, could respond with a takeover offer for Oi.
Oi shares were up 1.7 percent at 1.80 reais on Tuesday in Sao Paulo trading.
With Oi out of the auction, the result is likely to fall short of the expectations of the Brazilian government, which had structured bidding to maximize revenue from licenses as it struggles to meet its budget target this year.
"With one potential participant down and growing concerns about the current industry situation, there is one serious loser here: the government," said former communications minister Juarez Quadros. ($1 = 2.41 Brazilian reais) (Editing by Lisa Von Ahn and Matthew Lewis)