Yahoo is nearing a deal with America Online to combine the two struggling companies' Internet operations, The Wall Street Journal reported Wednesday.
The Journal cites unnamed people "familiar with the matter" as saying California-based Yahoo and Time Warner-owned AOL are negotiating a tie-up that could benefit them both.
Meanwhile, Microsoft and News Corp are in talks about a joint bid for Yahoo Inc that would add MySpace to a proposed Microsoft-Yahoo combination, newspapers reported on Wednesday.
An alliance with AOL would help Yahoo thwart a hostile takeover
bid by US software giant Microsoft, which is trying to buy the pioneering California Internet firm in a stock and cash deal originally valued at $44.6 billion.
Faded Internet star AOL, meanwhile, is eager to regain the luster of its stardom in the early days of the world wide web and find a new identity that renews its popularity.
Time Warner would reportedly merge AOL into Yahoo and pay for a 20 per cent ownership of the combined company, according to the Journal.
Yahoo would supposedly use the cash to buy back shares from some of the very stockholders Microsoft is threatening to woo in an effort to have Yahoo's board of directors ousted and replaced with people amenable to the takeover.
Talk of an AOL tie-up and massive stock buy-backs by Yahoo come as the firm's board of directors vows to explore all options to avoid having Microsoft's unsolicited offer shoved down its throat.
Yahoo is even apparently seeking help from longtime rival Google, whose dominance in Internet advertising is among the reasons Yahoo's revenues and share of the market have been eroding.
The company announced Wednesday it will launch a limited test of Google's AdSense for Search service, and in doing so, drew a sharp response from Microsoft.
"Any definitive agreement between Yahoo and Google would consolidate over 90 per cent of the search advertising market in Google's hands," said Brad Smith, Microsoft's general counsel, in a statement.
He added: "This would make the market far less competitive, in sharp contrast to our own proposal to acquire Yahoo. We will assess closely all of our options."
Yahoo's AdSense test is to last up to two weeks and be limited to no more than three per cent of Yahoo search queries. The programme will deliver Google ads alongside Yahoo's own search results.
Yahoo said the test will apply only to traffic from yahoo.com in the US and will not include Yahoo's network of affiliate or premium publisher partners.
It said the testing does not necessarily mean it will "join the AdSense for Search programme or that any further commercial relationship with Google will result."
Alliances with Google and AOL would be leverage for Microsoft to raise its bid, which Yahoo's board contends undervalues the company.
Smith said Microsoft remains committed to a $44.6 billion takeover offer for Yahoo.
Yahoo on Monday rejected a three-week deadline from Microsoft to accept the takeover but said it is open to a sweetened bid from the software giant or another bidder.
In an open letter to the Yahoo board of directors released over the weekend, Microsoft chief executive Steve Ballmer accused the company of avoiding serious negotiations over its unsolicited February 1 bid and warned that any further delays could result in a less attractive offer for Yahoo.
"If we have not concluded an agreement within the next three weeks, we will be compelled to take our case directly to your shareholders," he said.
Yahoo executives rejected the deadline on Monday, sending Ballmer a letter saying: "We continue to believe that your proposal is not in the best interests of Yahoo and our stockholders."
The letter also said Yahoo is open to a deal with Microsoft at a higher price.
Microsoft is betting that by combining with Yahoo, it can gain ground on Google's overwhelming dominance of the lucrative internet advertising sector.
Google's share of US online searches inched up nearly a percent to 67.25 per cent in March while the portions handled by Yahoo and Microsoft's MSN slipped slightly to 20.29 and 6.65 per cent respectively. (AFP)
Yahoo in tie-up talks with America Online