Carphone Warehouse agreed today to buy the UK arm of internet provider AOL from Time Warner for £370 million.
The deal will give Carphone around two million broadband customers and make it the third largest provider of high-speed internet in the UK.
It came as the mobile phone retailer revealed losses from offering "free" broadband to 625,000 of its Talk Talk customers will hit £70 million this year.
Carphone was one of the first operators in the UK telecoms market to offer customers combined internet and telephone services.
The deal with Time Warner for AOL will see Carphone acquire 2.1 million internet users, including 1.5 million on broadband to add to its own Talk Talk customers.
AOL is one of the longest-running providers of the internet in the UK. It was launched in the UK in 1996 - before Freeserve - and gave many British homes their first taste of the internet.
Carphone said today it will take on AOL's UK customers while AOL will continue to provide content on the web and manage online advertising.
It said the tie-up with AOL will save it money in relation to network infrastructure and marketing.
The deal is expected to be completed on New Year's Eve subject to approval from regulators.
Carphone chief executive Charles Dunstone said: "The acquisition of AOL's UK internet access business is transformational for our broadband business.
"This deal gives us significant scale to complement the rapid organic growth of our free broadband proposition.
"In addition, the joint development of AOL's already successful audience platform will bring us new advertising and content revenues in a proven and low risk manner."
Carphone's TalkTalk broadband deal - which offers customers "free" broadband if they pay £20 a month for a landline phone - has been plagued by problems since its launch in April as Carphone struggled to keep up with demand.
It originally thought the offer would create start-up costs of £50 million this year, but those estimates were widened by £20 million today.
Carphone said that once the deal was completed, current AOL customers would be able to maintain their present contract or join the Talk Talk service.
It added that it would continue to offer both AOL internet access and its own Talk Talk deal following the takeover.
Mr Dunstone has admitted that the offer of free broadband created a customer service "nightmare" for the firm.
It was forced to hire hundreds of extra staff as it struggled to cope with the higher than expected levels of demand.
It has also had to pay to use BT services while it waits for its own high-speed internet access into homes to be fitted.
Today it said it was largely over its customer service problems, with customers now waiting five weeks for broadband connection while queries to its call centres were answered within a minute. In June, it was reported that some customers were waiting up to three months for a connection.
The company received 625,000 applications for free broadband between the launch of the offer in April and the end of September.
Carphone said 421,000 customers were now linked to broadband while it had taken control of, or "unbundled", 370 BT phone exchanges so that it can run landlines into homes.
"We remain well on course for our target of 1,000 unbundled exchanges by May 2007," it added.
Peregrine Riviere, an investor relations spokesman at Carphone, said: "It has been pretty ugly at times over the last few months but we have invested a lot in customer services and we have got much better in connecting customers to broadband.
"We have made a lot of progress. You now only have to wait five weeks to get broadband compared with 10 weeks. We are hoping to bring that down to four weeks in the short term and then to two to three weeks."
He said the 625,000 applications for broadband were "much more than expected", with Carphone still receiving 15,000 new applications a day. That would give it nearly one million broadband customers by the end of the financial year in March.
Carphone, which is Europe's biggest mobile phone retailer, said it did not expect to be saddled with any costs relating to its broadband offer from next year.
It also revealed that total connections across the group were up 34% to 2.38 million in the three months to September 30 while subscription connections rose 16.3% to 960,000.
Carphone opened 66 stores in the second quarter to take its estate up to 1,921. It said it expected to open 300 new stores over the course of the year.
Mr Dunstone said: "We have had a very strong first half's trading."
Shares in Carphone lifted 5% today.
Keith Bowman, equity analyst at Hargreaves Lansdown Stockbrokers, said: "Although news in relation to higher broadband start-up costs is disappointing, the underlying story remains solid.
"The group's mobile phone business goes from strength to strength and most investors will accept that some short-term pain maybe necessary in order to make long-term gains via the roll-out of the broadband offering.
"Given that the shares had rebounded by over 20% before today's announcement in just the last month alone, some profit-taking comes as no surprise. Overall, market consensus opinion is likely to remain resolutely positive."Reuse content