Vodafone rallies, while RBS falls as FTSE 100 flatlines

* FTSE 100 down 2.51 points at 6,728.92

* Vodafone rallies on AT&T (NYSE: T - news) bid talk - Bloomberg

* RBS (LSE: RBS.L - news) falls after announcing set up of internal "bad bank"

* Meggitt (Other OTC: MEGGF - news) tumbles after cutting full-year guidance

By David Brett

LONDON, Nov 1 (Reuters) - Britain's FTSE 100 was flat early on Friday with heavyweight Vodafone leading the gainers on a media report that U.S. telecoms firm AT&T could soon make a bid, while RBS fell after announcing the creation of an internal "bad bank".

Vodafone, the UK's fifth-largest listed company by market capitalisation, added 9 points to London's blue chip index after Bloomberg reported late on Thursday that AT&T (Berlin: SOBA.BE - news) was exploring a potential takeover of Europe's largest mobile carrier, once Vodafone's disposal of its 45 percent Verizon stake is complete.

BofA Merrill Lynch, which sees the UK mobile company as a good cultural fit with AT&T, said it expects Vodafone's shares to re-rate by 1 times EBITDA or up 27 pence and a potential bid from AT&T could offer further upside.

By 0738 GMT, the FTSE 100 was down 2.51 points at 6,728.92.

Britain's top share index remained just 1.2 percent off the 13-year highs of May, having rallied 12 percent from June lows as investors tucked back into equities encouraged by an extended period of equity-friendly easy monetary policy from central banks.

Despite hefty gains in the year to date, Citigroup (NYSE: C - news) still sees equities as the most attractive value trade versus other assets.

"In equities, investors should position now for earnings leadership in the coming 12-18 months," it said. The broker advises taking long positions in selected cyclicals and financial and shorting defensives, and sticking with its REV strategy (risk, earnings momentum and value) with exposure to banks, insurance and autos.

UK lender Royal Bank of Scotland, however, fell 3.5 percent after it announced it is to create an internal "bad bank" to manage the run-down of its riskiest assets after the government stopped short of ordering a full break-up of the state-backed bank.

"Traders hoping for a treat were spooked by the Halloween numbers delivered by RBS this morning. A loss of over £600m proved a £1bn miss versus a £400m expected profit. The ring fencing of £38bn of bad loans, expected never to be repaid, avoids an actual good bank-bad bank split, but what really is the difference?" Marc Kimsey, Senior Trader at Accendo Markets, said.

"A further provision of £250m ensures the PPI nightmare continues. The bank is a long way behind peers Lloyds and Barclays (LSE: BARC.L - news) , and remains the ghoul of the sector."

And earnings concerns knocked British aircraft parts supplier Meggitt down 7.4 percent after it lowered its full-year revenue guidance after trading over the last four months had been slightly below its expectations.

Liberum said in a note that having spoken with the company, it suspects consensus full-year earnings per share will be trimmed by 3-5 percent and noted the shares trade on a 2014 price-to-earnings of 14.5 times and EV/EBIT of 11.4 times, which is 20 percent above its long-term average. (Reporting by David Brett)