Three owner Hutchison Whampoa has entered exclusive talks to buy O2 in a £10 billion deal which would create the UK's largest mobile phone operator.
Spain's Telefonica is selling O2 to the Hong Kong group after BT spurned the chance to buy the business - which began life as part of the telecoms giant as Cellnet - in favour of EE.
Three had 'ruled out' an acquisition of O2 in 2014 but has now changed its mind.
Tycoon Li Ka-Shing's Hutchison group said it had entered talks "over a period of several weeks" to buy O2 for £9.25 billion in cash followed by deferred payments of up to £1 billion.
Telefonica confirmed the talks, saying the deal marked another step in its transformation process which it said would "allow the company to strengthen its financial flexibility".
Industry figures from Espirito Santo show EE as currently the biggest of the mobile phone players with 35.2% of the market followed by O2 on 28.5% - but the latter combined with Three's 8.4% share would see it climb to first place.
Hutchison said the transaction remained subject to due diligence over O2, agreement on terms and signing of agreements, and obtaining the required corporate and regulatory approvals.
A separate statement from Telefonica said:
"Telefonica has entered into an exclusivity agreement with Hutchison Whampoa in relation to Hutchison's potential acquisition of O2 UK, Telefonica's subsidiary in the United Kingdom, for £10.25bn in cash."
It comes a month after BT said it had entered exclusive talks over a £12.5 billion deal to buy EE.
Telefonica snapped up O2 for £17.7 billion in 2005. The business had been spun off from BT in 2001.
Its proposed takeover by Hutchison comes as Europe's telecoms firms jostle to reposition themselves amid a consolidation in the sector - with BT's move on EE designed to focus on a convergence between fixed and mobile services. Vodafone, the number three player in the mobile market, has outlined plans to offer broadband services and has been subject to speculation that it has designs on Sky to strengthen its position in the UK and give it access to TV operations in Europe.e
The group has already moved for cable operators in Spain and Germany over the last couple of years.
Meanwhile, Li's move for O2 represents the latest UK acquisition for the tycoon across a range of sectors. Earlier this week his Cheung Kong Infrastructure group bought train rolling stock firm Eversholt for £2.5 billion. It will sit alongside his other UK investments which include retailer Superdrug, Northumbrian Water, Southern Water, Felixstowe port and UK Power Networks.