BT has entered exclusive talks over a £12.5 billion deal to buy Britain's biggest mobile phone operator EE.
The disclosure comes after days of speculation over whether BT would opt to bid for O2 or rival EE, which is owned by Deutsche Telekom and Orange, as part of its long-awaited return to the mobile phone sector.
BT will begin several weeks of talks over the potential cash and shares deal worth £12.5 billion, a move which is set to result in Deutsche Telekom holding a 12% stake in BT and Orange taking a 4% stake.
O2, formerly known as BT Cellnet, was spun off from BT in 2001 before being bought by Spain's Telefonica for £17.7 billion in 2005.
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Telecoms operators are increasingly focused on moving into ''quad play'' - bundling together landline, mobile, internet and TV services for customers.
'Most advanced network'
BT said the acquisition of EE, which has 24.5 million customers, would give it ownership of the UK's most advanced 4G network, providing it with greater control in terms of future investment and product innovation.
In July, BT took its first big step back into the mobile phone market as it launched a new business service aimed at delivering fixed line and mobile calls to the same handset.
It is already planning to launch a mobile phone business for the wider public by the end of the current financial year to the end of March.
The latest move comes as BT is also engaged in a TV football war with Sky, as it tries to lure broadband customers with free Premier League broadcasts. It has also bought Champions League rights.
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BT said it expects significant synergies from the EE combination, mainly through network and IT rationalisation, as well as back-office consolidation and savings on procurement, marketing and sales costs.
EE 'more desirable'
It also expects to generate significant benefits from selling fixed-line services to those EE customers who do not currently take a service from BT, as well as from the sale of converged fixed-mobile services to BT's existing customers.
Paolo Pescatore, a communications analyst at CCS Insight, said EE was a more desirable asset for BT than O2.
He added: "EE has a more developed 4G network and has more mobile subscribers than any other UK operator. This offers a significant and highly attractive target market for BT to cross-sell fixed-line services to.
"More importantly however, it removes a converged rival from the market. Given that EE had multi-play aspirations of its own, BT will now face one fewer competitor."
However, he warned a deal with EE could be trickier and more time-consuming than with O2.
He added: "The deal will be subject to more stringent regulatory hurdles than buying O2. It combines the UK market-leader in fixed-line with the number one mobile operator. We believe it is unlikely that Ofcom would block the deal, but the combined entity could be forced to dispose of some spectrum."
Speculation over a deal was triggered last month when BT said it had been approached by the owners of EE and O2 about potential takeovers.
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Hatfield-based EE was created from the merger of mobile phone brands Orange and T-Mobile in 2010 before the business went on to launch the UK's first 4G network in 2012.
It has invested £1.5 billion over three years to roll out superfast 4G and aims to reach 98% of the UK population by the end of this year.
BT said: "The proposed acquisition would enable BT to accelerate its existing mobility strategy whereby customers will benefit from innovative, seamless services that combine the power of fibre broadband, wi-fi and 4G.
"BT would own the UK's most advanced 4G network, giving it greater control in terms of future investment and product innovation."