Secret merger talks between the BBC and Channel 4 are on the verge of collapse, as frustrated executives of the corporation believe that a “Frankenstein” tie-up between the two would destroy value and break European law.

Channel 4 formally proposed last month a merger with Worldwide, the BBC’s commercial arm, to create a “British Rights Company” after reports that ministers and regulators were receptive to the idea.

The BBC reluctantly agreed to negotiate with Channel 4, believing that it would be impolitic not to, given the political interest in a possible deal. However, the discussions did not progress far because the BBC was reluctant to allow Worldwide’s overseas business to be included.

Andy Duncan, Channel 4’s chief executive, is understood to have then proposed that a tie-up include only Worldwide’s UK businesses, which include the Radio Times and other magazines, commercial production businesses and its half share in the UK TV family of pay-channels.

The early-stage nature of the discussions meant that no agreement was reached on who would run the business. BBC Worldwide is run by John Smith, who reports to Mark Thompson, the BBC’s Director-General.

However, advisers close to the BBC concluded that any Worldwide-Channel 4 agreement would amount to “Frankenstein M&A” that would create a larger company without commercial logic. NM Rothschild has been advising Channel 4 while Goldman Sachs is working with the BBC.

With a deal with BBC Worldwide looking unlikely and hopes of securing extra public funding fading, Channel 4 could faces the prospect of being cajoled into a new “wider entity”. The enlarged public service broadcaster, which would act as an alternative to the BBC, is one of the options expected to be outlined in a draft report by Lord Carter on the future of digital Britain due to be published on January 26.

Channel 4 is facing a shortfall of about £100 million a year if it is to maintain its existing mix of entertainment and serious programming into the next decade, as its advertising and audiences fall. It wants ministers to agree to a support package, and is keen on a tie-up with Worldwide because profits generated by the BBC’s commercial arm could be used to prop it up.

Heading the BBC objections is the belief that the existing “first look” agreement, which gives Worldwide the first chance to commercially exploit properties such as Doctor Who and Strictly Come Dancing, could not survive if Worldwide merged with Channel 4. That would hurt the profits of Worldwide, which last year made £112.5 million. The BBC also fears that any deal could fall foul of EU rules on state aid. Regulatory approval could take well over a year.

There is also scepticism about what Channel 4 would add in a deal. The only obvious area of synergy with Worldwide is the UK TV channels. However, these are also half-owned by Virgin Media, which may not be willing to agree to savings.

BBC estimates suggest that Channel 4 could save up to £90 million a year by 2012, through a mixture of measures that fall short of a merger. The BBC is willing to offer Channel 4 some technologies and services,.

Channel 4 disputes those figures and believes that it needs greater help to maintain its status. In a speech yesterday, Mr Duncan said that he had been “carefully considering all options for Channel 4’s future funding”. However, he insisted that Channel 4 needed public support because getting help from private sources “makes no sense”, adding: “Mixing oil and water doesn’t work. It just makes a mess.”

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