His firm, Hong Kong-based Hutchison Whampoa, already owns the Three mobile network, and combining it with O2 would create the UK's biggest mobile group.
However, the move could face tough scrutiny from competition regulators.
It would reduce the number of major operators in the UK from four to three, which might not benefit consumers.
Further consolidation within the telecommunications industry is already on the cards, with BT Group in talks to buy rival operator EE.
If a deal is agreed it would have to be approved by competition regulators in Brussels.
Currently the UK mobile market is dominated by O2, EE, Vodafone and Three.
However, Hutchison Whampoa group finance director, Frank Sixt, pointed to deals in other countries, including Ireland, which were given the green light and which also reduced the number of competitors in the market from four to three.
"The European Commission has taken a positive view of four-to-three consolidations of mobile in three cases now...and we believe that the precedents that they have set in those transactions will apply for this transaction," he said.
Mark Newman, chief research officer at telecoms consultancy, Ovum, thinks there may still be grounds for concern.
"The big question we should be asking ourselves is whether the consolidation will result in prices going up," he said.
"It's worth looking at the Austrian market which has gone from five operators a few years ago to three today. It appears as though prices have gone up in the Austrian market."
O2 said in a statement: "Three is known for campaigning on behalf of its customers, much like O2.
"We are confident that an agreement will mutually benefit the customers of both companies, as well as drive better value, quality and investment in one of the most digitally competitive countries in the world."
These are turbulent times for the UK mobile phone industry - and for its customers.
Just a few years back, there were five operators - Orange, T-Mobile, Vodafone, O2 and the scrappy outsider, Three.  Now Three owner Li-Ka Shing's move for O2  means it is likely there will be three giants in charge of our phones and the prices we pay to use them.
BT's move on EE, the merger of Orange and T-Mobile, appeared to raise few competition concerns because it won't cut the number of choices for consumers. Hutchison's plans are a different matter. Three has been a small player making a big impact by bold pricing moves such as offering free international roaming and unlimited data deals.  But combined with O2 it would be the biggest operator, and might be keen to raise prices.
The competition authorities in Brussels and in London seem certain to want to have a look at the deal, though some might argue that consolidation in Europe's most competitive mobile market is inevitable and will lead to more investment in better networks.
One company which might be cheering the regulators on is Vodafone. It was already unhappy about the implications of any  BT/EE deal - now what was the UK's global telecoms powerhouse faces being an also-ran in its home market.
Hutchison said in a statement that the exclusive negotiations with Telefonica will take a period of several weeks.
"Shareholders and potential investors of the company should note that such negotiations may or may not result in any transaction, and accordingly are advised to exercise caution when dealing in the shares of the company," it said in a filing to the Hong Kong stock exchange.
Hutchison shares jumped 4% on the announcement after they resumed trading in Hong Kong. They had been suspended on Friday morning pending the statement.
Mr Li has spent more than £20bn on overseas acquisitions in recent years. Earlier this week, he agreed to buy the UK's Eversholt Rail Group for £1.1bn.
The 86-year old is also undertaking a major reorganisation of his business empire, which has interests in property, energy, ports and telecoms.
The conglomerates Cheung Kong Holdings and Hutchison Whampoa are both controlled by Mr Li. He plans to merge them and spin off their property assets into a new company, also to be listed in Hong Kong.
Asia's richest person Li Ka-shing is in talks to buy Britain's second-largest mobile provider O2 for up to £10.25bn ($15.4bn) from Spain's Telefonica.