[peter noble]

LONDON (Reuters) - U.S. media mogul Barry Diller has been discussing a possible joint bid with Viacom Inc. chairman Sumner Redstone for Vivendi Universal's show business empire, sources close to the auction said on Tuesday.

Diller, a former Vivendi executive who owns a stake in the entertainment assets, is eyeing the multibillion-dollar auction of the film, TV and theme park business, and has been talking to Viacom chief Redstone about a possible deal, the sources said.

A Diller/Redstone duo would be an ironic twist to a Hollywood saga that saw the two moguls go head-to-head for Paramount studios in the 1990s -- a battle Redstone's Viacom eventually won but only after raising its bid by $2 billion.

In a joint bid for the Vivendi assets, the octogenarian Redstone would keep the cable television business and carve out Universal Studios for Diller, giving him ownership of a Hollywood studio he has long desired, the sources said.

Under a standstill agreement set in place when Diller sold his USA Networks business to Paris-based Vivendi two years ago, Diller is not formally allowed to bid in the auction.

But Vivendi, the world's second biggest media group, is keen to secure a deal to cut debt -- and might waive that clause if Diller teams up with another bidder in the auction which has attracted some of Hollywood's biggest names, one source said.

Viacom declined to comment. A spokesman for Diller's InterActiveCorp also declined to comment.

Vivendi kicked off the auction of Vivendi Universal Entertainment (VUE) last month to slash debts that almost brought the 148-year-old former utility to its knees last year.

Five bidders made the cut into the second round of the auction earlier this month -- Viacom, Liberty Media Corp., Metro-Goldwyn-Mayer Inc., General Electric Co.'s NBC and Edgar Bronfman Jr.

Vivendi hopes to pick a winner in September, according to sources familiar with the auction. One source said on Tuesday Vivendi may keep all five bidders in the running until the end, rather than drawing up another short-list as widely expected.

FAVORITE TO WIN?

Viacom has so far indicated it is only interested in Vivendi's cable television assets Sci Fi and USA, and possibly the television production business, other sources close to the matter have said.

However, the New York Post reported on Tuesday that Viacom could purchase all of VUE and then spin off the movie studio and theme parks into a private company controlled by Diller.

Such a deal would avoid a tax liability incurred from breaking up the entertainment business, the newspaper said.

One of the sources on Tuesday suggested Diller may seek talks with other bidders too. InterActiveCorp, which Diller heads, owns just over 5 percent of VUE and $2.0 billion in preferred stock. Diller himself owns a stake of around 1.5 percent of VUE.

Cash-rich Liberty Media, headed by cable king John Malone, has been seen as an early favorite in the auction.

Other sources close to the auction said on Tuesday that Liberty's bid was one of the most financially solid. But the U.S. company has already been rebuffed in a bid to open exclusive talks with Vivendi.

MGM posted one of the highest bids. People familiar with the situation said on Monday the Los Angeles-based film studio had told Vivendi it would raise its bid to $11.5 billion, but only if it got more access to financial data.

In a letter to Vivendi Chief Operating Officer Jean-Bernard Levy, MGM threatened to walk away from the auction unless it received more information by July 21, those sources said.

This could be real bad news, remember Diller hired Hammer et al.