Carphone lifts stakes with £370m purchase of AOL UK

Carphone Warehouse has upped the ante in the broadband market after buying AOL's UK access business for £370m, propelling it into third place in the UK behind NTL and BT.

It is the mobile phone retailer's largest acquisition and adds 2.1 million customers, most of whom are broadband subscribers, to its customer base.

Carphone had been considered the front-runner to win the auction against other bidders, including Sky and Orange, given AOL's desire to keep its brand active in the UK by maintaining its content portal. Unlike the rival bidders, Carphone does not have a recognisable brand in the internet content market and will use AOL's portal as a result of the deal. Charles Dunstone, the chief executive of Carphone, said the AOL portal will act as a "landing pad" for customers.

The agreement mirrors BT's deal with Yahoo! whereby BT takes charge of connecting the customer to its network while the media company concentrates on providing attractive content for the portal. AOL and Carphone have also struck a revenue-sharing agreement to sell advertising on the portal.

The AOL business recorded an operating profit of only £14.1m in 2005, making the deal appear expensive. However, analysts believe Carphone can secure up to £100m in tax benefits on AOL's assets.

More significantly, the company's larger customer base will accelerate its path to profitability in the broadband market. Carphone has invested heavily in installing its own infrastructure into local exchanges but needs customer density to make a sufficient return on the cost of the network roll-out.

Carphone says it needs about 250 broadband customers to make an exchange profitable. Mr Dunstone said taking on AOL's business will boost its customer base to about 500 customers per exchange.

Carphone launched its broadband service in April as a free add-on to customers who subscribe to its fixed-line voice packages. It has since suffered a barrage of bad broadband publicity due to poor customer service and problems connecting new subscribers in a timely fashion. As a result of hiring more customer service staff and higher wholesale network costs, it expects to lose £70m on its broadband entry this year, partially offset by a £10m contribution from the AOL business. After integrating AOL UK, it expects to achieve pre-tax profit of £60m-£80m on its broadband business.

Carphone has received 625,000 applications for free broadband but it said 78,000 of those customers have cancelled orders. Mr Dunstone said the firm is receiving 15,000 to 20,000 applications a week for free broadband and is investing in more customer service staff, specifically technical workers, to cope with the demand.