Carphone Warehouse, the British phones and broadband group, has bought AOL in the UK from America's Time Warner for £370 million in cash.

The deal, which ends a four-month auction for the Time Warner arm, gives Carphone Warehouse 2 million new customers and instantly turns it into the UK's third-largest broadband service provider.

Carphone and its chief executive Charles Dunstone have been pushing heavily into the broadband market, launching "free" services to customers in April. It currently has 625,000 customers but has been hit with delays migrating accounts and problems servicing customers from call centres.

AOL is a veteran of the British internet market, launching in the UK as a pioneer in 1996, two years before Dixons launched Freeserve in 1998.

Mr 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."

Carphone said it would provide co-branded services with AOL and the internet service provider would manage online advertising sales through a revenue-sharing agreement.

Carphone will also acquire AOL's existing management and its internet infrastructure.

Mr Dunstone added that buying AOL would generate new revenues from both advertising and content and would be low risk.

Last year, AOL in the UK made operating profits of £14.1 million on revenues of £442.1 million.

The deal came as Carphone suffered a further setback to its "free" broadband effort as installation delays and increased customer services costs forced it to bump up expected start-up losses on the project by 40 per cent to £70 million.

As he delivered an update on trading for the second quarter, Mr Dunstone said Carphone had had to recruit additional call centre staff to deal with the surge in demand for its broadband services. He said customers still had to wait an average five weeks for a connection to be established.

Mr Dunstone said this and increased wholesale broadband costs would push up initial broadband losses by £20 million. Despite the setback, and with Carphone under pressure to improve the waiting time for customers, Mr Dunstone said the losses would not hit full-year headline profits. He also said he expected interim profits to be 50 per cent higher year on year.

Carphone said that, as at the end of last month, it had received 625,000 applications for free broadband, with 421,000 customers currently "live" with the service. However, it said that just 20,000 customers were on "unbundled" lines by the end of its second quarter, far fewer than many analysts had predicted.

Carphone is working with Openreach, a special company set up by BT to free up access to its local exchanges, but for Carphone this is taking longer than expected.

Dan Gardiner at Bridgewell said: "This is considerably less than our forecast and will have a significant impact on CPWs costs. Reflecting this and increased customer service costs, CPW has had increase its forecast for losses this year by £20m. This re-inforces our concerns over the market's expectations on the profitability of CPW's broadband proposition."

Mr Dunstone said Carphone had so far unbundled 370 exchanges and that Openreach had handed over a further 476. He said the group was still "well on course" with its target of opening up 1,000 exchanges by next May.

"We have had a very strong first half's trading," Mr Dunstone said, as he described the response to Carphone's free broadband offer as "exceptional". He also insisted that the average answering time in the call centres was among the lowest in the country according to independent research.

During the 13 weeks to the end of September, Carphone, which also sells mobiles and the TalkTalk fixed line services, opened a net total of 66 new stores, taking the total to 1,921. Total connections, including all of these services, rose by 34 per cent to 2.38 million.

Shares in Carphone fell 9p, or 2.7 per cent, to 324.5p. Carphone is a FTSE 250 firm worth almost £3 billion. For more on the shares click here

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive