Telefonica is in advanced talks with KPN to takeover the company's German mobile network, E-Plus, according to a number of sources close to the negotiations.
Talks are ongoing but a deal could be announced early this week, sources have told the Financial Times.
One possible scenario being discussed is Dutch telecom giant KPN receiving cash and a small number of shares in Telefonica Deutschland as part of the deal.
A combined network of E-Plus and O2 would become the biggest mobile operator in Germany, overtaking both Vodafone and T-Mobile. E-Plus is currently the third largest network in the country whilst O2 is the fourth.
Telefonica will pay around $6 billion (£3.9bn) for E-Plus, according to the FT's sources. There is a risk that the EU's competition authority could block the move, although the firms are likely to offer concessions to ensure it can go ahead.
A merger would bring the number of mobile operators in Germany down from four to three, not just reducing competition but also choice for consumers.
A source has told Bloomberg that the companies did in fact reach a pre-agreement to merge their German operations - which will save the companies billions of euros - last year, before talks broke down.
"A deal makes sense for both KPN and Telefonica because Vodafone and Deutsche Telekom have such a strong position in the country," Emmanuel Carlier, a Brussels-based analyst at ING Groep NV told Bloomberg.
"This could save a lot of operational costs and capital expenditures as the market is only getting more competitive."
Both Telefonica and KPN have declined to comment.