Qwest is reportedly sizing up XO Communications as a possible takeover target, a source says.

Speculation that Qwest might pursue XO and other, smaller service providers surfaced after Qwest lost out to Verizon in its bid for MCI. Observers at that time said Qwest might look to acquire a smaller carrier with nationwide facilities, a focus on enterprise customers and little debt - such as one that has emerged from Chapter 11 bankruptcy. XO and Global Crossing have done so.

A source says Qwest was performing due diligence on XO last week as a precursor to perhaps making an offer for the carrier. Qwest and XO declined to comment on "rumor and speculation."

Analysts say the union makes sense. Qwest CEO Dick Notebaert has said the carrier would be looking to accumulate smaller assets after losing out on MCI, including those divested by SBC and Verizon as they integrate acquired carriers AT&T and MCI, respectively.

"Qwest has been saying that they would look to collect similar local assets and business customers by buying smaller companies," says Donna Jaegers, an analyst at Janco Partners. "It makes sense. XO's got fiber in 37 markets - they have about 3,000 buildings on fiber. They have a lot of collocation facilities with the local phone companies, and they got that by buying Allegiance [Telecom]."

XO last year outbid Qwest for Allegiance. XO has 1.16 million metropolitan fiber miles throughout 40 major U.S. cities, including the 30 largest.

"It's very consistent with what [Notebaert] said," says Jeffrey Halpern of Sanford Bernstein, which hosted a conference last week at which Notebaert spoke and reiterated plans to "roll up" smaller assets.

"He has two problems: He has a scale problem and he has an access problem," he says. "What he said during and following his presentation was that he believes consolidation remains necessary and that Qwest is likely to be an active member in driving that; and that the probable strategy is a roll-up strategy - there isn't one acquisition that solves the problem. You could assemble a set of assets that could be competitive with an AT&T and an MCI in the enterprise space."

Thomas Nolle, president of consultancy CIMI, says he has heard the Qwest/XO due diligence reports, as well.