May 19 (Bloomberg) -- Microsoft Corp., the world's biggest software maker, revived the possibility of a deal with Yahoo! Inc. to challenge Google Inc. after failing to agree on a merger. Microsoft said yesterday it's exploring an agreement with Yahoo that stops short of a full takeover. Redmond, Washington- based Microsoft didn't elaborate on the proposal and said it ``reserves the right'' to reconsider its bid to buy all of Yahoo. The proposal gives Yahoo, owner of the second-most popular Web search engine, another chance to forge an agreement with Microsoft as investor Carl Icahn threatens to oust the Internet company's board. Yahoo Chief Executive Officer Jerry Yang demanded a higher price than Microsoft's $47.5 billion offer, prompting Microsoft CEO Steve Ballmer to abandon talks on May 3. ``Many analysts expected Microsoft to retrace its steps and seek a deal with Yahoo,'' said Raffaella Sommariva, a fund manager at AZ Fund Management SA in Luxembourg, which oversees the equivalent of $14.5 billion. ``An accord would be a great opportunity for both of them.''
Yahoo said in a statement yesterday that it is open to pursuing any transaction in the best interest of investors. The company said it will continue to consider all of its options, including any proposal from Microsoft.
Yahoo rose 82 cents, or 3 percent, to the equivalent of $28.48 at 9:31 a.m. in German trading from the U.S. close of $27.66 on May 16. Microsoft fell 20 cents to $29.79 in Germany from the U.S. close of $29.99 last week, while Google lost 66 cents to $579.41 in European trading. The agreement Microsoft and Yahoo are discussing involves Yahoo carrying search advertisements from Microsoft, the Wall Street Journal said yesterday, citing people familiar with the matter. That may be a way for Microsoft to scuttle talks between Yahoo and Google for a similar partnership, the newspaper said. Yahoo said in April it would run some Google ads next to its search results to boost sales. Google made as much as 70 percent more in sales from each query at the end of last year, Yahoo has said. Google CEO Eric Schmidt said on May 8 that while the test has ended, the two companies are on ``very friendly'' terms. ``Investors in Yahoo were very disappointed after Microsoft abandoned the talks,'' Sommariva said. ``Microsoft hasn't managed to reach a critical size with MSN to compete and Yahoo is battling with Google.''
Icahn, who has the backing of Paulson & Co., the New York hedge-fund manager run by John Paulson, said last week that a combination of Microsoft and Yahoo would create ``a force strong enough'' to fight Google. Microsoft hasn't held talks with Icahn, a person familiar with the situation said yesterday. Icahn didn't return a call seeking comment. ``The best strategy for Yahoo is to embrace Microsoft,'' Troy Mastin, an analyst at William Blair & Co. in Chicago, said in a Bloomberg Television interview last week. He predicts Yahoo shares will perform in line with the market. ``If they structure a deal correctly, they might still be able to retain a lot of the control and autonomy that they have today.'' Microsoft spent three months wooing Yahoo to expand its Internet-search business and compete with Google in the $41 billion worldwide online advertising market. Microsoft said its next move will depend on discussions that may take place with Yahoo, shareholders of the two companies, or other parties. Microsoft spokesman Frank Shaw and Yahoo spokeswoman Tracy Schmaler declined to comment.
`Major New Initiative'
Microsoft and Yahoo had discussed a partnership designed to boost each other's share of the Web search and advertising market, people briefed on the discussions said last May. Separately, Microsoft said yesterday it will talk about a ``major new initiative'' in its search engine technology on May 21. Microsoft will also make changes to its online branding, which is ``fragmented and confusing,'' Kevin Johnson, president of Microsoft's Internet business, said in a memo to employees. The company will ``double down'' on investments in Europe, pursue small acquisitions and expand partnerships to build up the online business, he said. Online ad sales reached $41 billion worldwide last year, according to Piper Jaffray & Co. Microsoft projected that may almost double by 2010. Icahn disclosed that he owned 10 million Yahoo shares and options to buy 49 million more. He submitted his own slate of nominees for Yahoo's board, including himself, Dallas Mavericks owner Mark Cuban and former Viacom Inc. CEO Frank Biondi. All 10 of Yahoo's current directors are up for re-election at the annual meeting on July 3. The 72-year-old investor, who helped orchestrate Oracle Corp.'s takeover of BEA Systems Inc., said in a letter to Yahoo's board that directors had ``botched'' talks with Microsoft. Yahoo disputed the claim, saying Icahn had a ``significant misunderstanding'' of the discussions.