BT is mulling a £1bn bid for rival Colt Telecom in a make-or-break attempt to turn around its struggling IT services division.
It is believed that BT chief executive Ben Verwaayen is interested in Colt's network, focused on 32 European cities, to bolt onto his loss-making Ignite operation.
The idea is understood to have been discussed at board level over the past few weeks and well-placed sources said BT may hold informal talks with Colt's chief executive Peter Manning this summer.
If BT were to pounce, it would mark the end of its troubled restructuring phase, when the company was forced to cut costs, demerge its mobile arm and sell off property and Yellow Pages to reduce debt.
Investors saw the first real signs of normality returning to the company last week when BT's new finance director Ian Livingston announced that the company would start paying dividends.
While BT refused to comment, sources close to the company said it is interested in acquiring part of Colt's business.
Analysts said Colt's continental European assets – that include networks in cities such as Paris, Frankfurt and Brussels – would be a good fit.
Like most of its peers, Colt is suffering from the severe downturn in the market, exacerbated by the collapse of Global Crossing, and the problems surrounding Energis.
Once a FTSE 100 company, Colt's shares are today worth 48p, valuing the company at £723m. At its peak, in March 2000, the group was valued at £27bn.
But many analysts believe that the company is extremely undervalued given the size of its network and the quality of its customer base, which includes companies such as Reuters, Siemens and Deutsche Bank.
Unlike BT, Colt has no obligation to provide a "universal telecoms service" to companies and residents.
Benedict Evans, analyst at WestLB Panmure, who rates the company as a "buy", said: "Colt is perhaps the purest and most elegant example of an alternative carrier ... [able] to cherry-pick the best customers." But a question mark hangs over BT's acquisition strategy.
BT cannot force Colt into selling off part of its network because the company is funded for the next few years with £1.2bn of cash on its balance sheet.
Therefore, BT could form a partnership with Colt – where it could take a minority equity stake for access to its network – or it could launch an outright bid then sell off the unwanted assets.
Whichever option BT takes, its success would be in the hands of Fidelity, the Boston-based fund management group that owns 54 per cent of Colt.
Fidelity founded Colt in 1993 and has stuck with the company through good times and bad. Last December it pumped nearly £500m into Colt by backing a rights issue, priced at 62p-a-share.
Because of Fidelity's commitment, many analysts believe that it would only sell out for between £1 and £1.50 a share. If BT acquires Colt then it would safeguard the future of Ignite.
Earlier this year, Mr Verwaayen warned all employees that any Ignite unit making a loss by 31 March 2003 would be shut down.
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