UPDATE 3-US court rejects FCC cable ownership limit

* Ruling could spark industry consolidation
* Court called FCC rule arbitrary and capricious

* Comcast, Cablevision shares higher (Adds Comcast comment, details from court ruling, analyst report; updates stocks)

WASHINGTON - A U.S. court struck down a rule limiting a cable company to no more than 30 percent of the pay television market, a victory for companies like Comcast Corp (CMCSA.O) that could spark a wave of industry mergers.

The U.S. Court of Appeals for the D.C. Circuit ruled on Friday that the Federal Communications Commission's rule, adopted in late 2007, was arbitrary and capricious and vacated it. The regulation was first set in 1993, but has been repeatedly challenged.

Shares of Comcast, which brought the case and is the biggest U.S. cable provider with a 24 percent market share, were up 0.3 percent to $15.60 in afternoon trading on Nasdaq. The stock of smaller provider Cablevision Corp (CVC.N) was up 2.9 percent to $22.40 on the New York Stock Exchange.

The court sharply criticized the FCC, saying the agency's dereliction in this case is particularly egregious because it failed to heed the court's past order to take other providers into consideration when setting a new cap.

The commission has failed to demonstrate that allowing a cable operator to serve more than 30 percent of all cable subscribers would threaten to reduce either competition or diversity in programming, the court said.

The judges pointed to rising competition among video providers, including satellite companies like DirecTV Group Inc (DTV.O) as well as telephone companies like AT&T Inc (T.N) and Verizon Communications Inc (VZ.N), which have been rolling out their own subscription television services.

Cable operators, therefore, no longer have the bottleneck power over programming that concerned the Congress in 1992. the court said.

Telephone and cable providers over the last few years have been jumping into each other's businesses so they can offer subscribers a package of television and communications services -- a bundle that can help boost their profits.

ROOM FOR MERGERS

The ruling, which could spark a round of mergers among companies that provide pay TV services, presents a major challenge for new FCC Chairman Julius Genachowski, a Democrat, who will now have to decide whether to appeal to the Supreme Court, draft a new rule, or abandon the regulation altogether.

FCC spokeswoman Jen Howard declined to comment.

The ruling came one day after the full slate of FCC commissioners voted unanimously to launch an inquiry to examine the state of competition in the U.S. wireless industry, a step that could lead to probes of other sectors including cable and broadband.

A Comcast said the ruling was a vindication.

This important decision affirms that rules must reflect the changing realities of the dynamic video marketplace where today consumers have more choice in video providers and channels than ever before, spokeswoman Sena Fitzmaurice said.

A Stifel Nicolaus analyst report said the ruling could pave the way for Comcast to buy cable assets including Cablevision, Charter Communications Inc (CHTRQ.PK) or Cox Communications, but it could also still face new FCC restrictions and a separate antitrust review.

We believe regulators are likely to eventually create a new cap or other rules that give cable companies more headroom, the report said.

Media Access Project, a public interest group, expressed disappointment with the ruling and vowed to fight the cable industry's anti-competitive ownership structure that has raised prices and limited choices for consumers.

This is not the end of the fight, MAP President Andrew Jay Schwartzman said.

FCC Commissioner Robert McDowell, a Republican who voted against FCC decision to impose a cap, said the agency's case was vulnerable.

It was clear in December 2007... that the effort to re-justify the very same cap that the D.C. Circuit first struck down in 2001 was even more vulnerable to court challenge the second time around, McDowell said.

The case is: Comcast Corporation, National Cable & Telecommunications Association et al v Federal Communications Commission and USA, CCTV Center for Media & Democracy et al, No. 08-1114. (Reporting by Jeremy Pelofsky, John Poirier; Editing by Gerald E. McCormick, Leslie Gevirtz, Tim Dobbyn)