Carphone Warehouse yesterday agreed to buy Time Warner's AOL internet access business in the UK for £370 million in cash to become Britain's third-biggest broadband service provider.

Shares in Europe's biggest mobile retailer closed up 26.75p at 360.25p on the deal, which it said would give it a broadband customer base of about 1.5 million and add £10 million to pretax profit this year, restoring its original forecast.

Earlier yesterday, Carphone said a £10 million rise in its forecast for underlying retail and fixed-line profits would be wiped out by an extra £20 million in broadband losses.

"We have been a victim of our own success," said corporate affairs direct or Peregrine Riviere, adding that the cost of dealing with a flood of new customers to its broadband service had led to the reduced profit forecast.

Carphone, which sparked a fierce price war in April with a "free broadband" offering for customers signing up for its TalkTalk fixed-line service, said it would fund the purchase of the AOL business by extending existing bank facilities and it expected the deal to be complete by the end of this year.

Carphone, which has made a string of acquisitions to boost its fixed-line business, said the deal should boost pre-tax profits by £30 million to £40 million in its next financial year.

"This deal gives us significant scale to complement the rapid organic growth of our free broadband proposition," Carphone chief executive Charles Dunstone said in a statement.

The deal will put Carphone in third place in UK broadband provision b ehind BT Group Plc and NTL:Telewest. Carphone expects costs at its broadband arm to be £70 million this year, compared with earlier guidance of £50 million.

The rise stems from hiring hundreds more customer service staff to cope with demand, and also from slow progress in local loop unbundling, which involves taking control of the lines that run from BT's phone exchanges to customer homes.

Until Carphone unbundles BT lines and can offer its own broadband product, it is forced to provide them BT wholesale broadband and continue making losses. Connections only becomes profitable when customers use Carphone's own broadband product.

Of Carphone's 625,000 broadband customers at the end of the second quarter, only 20,000 of them were on unbundled lines.

Under Carphone's "free broadband" offering, customers signing up to spend about £20 a month for its fixed-line service and line rental get free high-speed Internet access.

Carphone said it had seen no let up in people signing up for its offer - 15,000 a week - and would transfer "significant" volumes of users to unbundled lines in the next three months. The company said its mainstay mobile retailing business, which accounts for most of its profits, was performing well and it reported a 34 per cent rise in total mobile connections signed up on behalf of networks for the second quarter.

Prepay connections surged 59 per cent, while more lucrative subscriptions or contract connections were up 16.3 per cent. Mr Riviere said it expected the "mid-teens" percentage growth in contract connections to continue for the rest of the year.