MS, Yahoo mull media partner options: Source

Meanwhile, talks have continued for months between Yahoo and Time Warner over a potential merger of AOL with Yahoo to create a more formidable advertising and media player, but they are no closer to a deal, a source close to the matter said.

Shares of Yahoo jumped as much as 9 per cent on Wednesday after the Wall Street Journal reported that Microsoft, positioning for a new run for Yahoo8217;s search business, had in recent days approached media companies to join together on a deal that would effectively lead to Yahoo8217;s breakup.

The Wall Street Journal also said Microsoft met with activist investor Carl Icahn in recent days to encourage him to press his proxy battle for control of Yahoo8217;s board, the first sign Microsoft welcomed his month-old campaign. This development also was attributed to unnamed sources familiar with the talks.

Icahn was not available to comment on the report.

Microsoft, Yahoo, Time Warner and News Corp all declined comment.

REVIVING HOPE

Wall Street analysts said the latest news revived flagging hopes among some investors that Microsoft was still interested in doing a deal with Yahoo. 8220;The hopes that Microsoft would come back were getting crushed over the last 10 trading days,8221; Collins Stewart analyst Sandeep Aggarwal said.

Yahoo stock ended the day up 3.4 per cent at 20.88. The stock had traded as low as 19.58 on Tuesday, near its level in late January before Microsoft made its unsolicited takeover bid for Yahoo, sending the stock above 30 by mid-February.

Microsoft shares fell 3.7 per cent to 25.88 on Wednesday. In the prior day8217;s trading, Microsoft fell to two-year lows of 23.19, intraday, before recovering.

Analyst Youssef Squali of Jefferies 038; Co said the sharp Yahoo stock reaction was most likely a defensive move by short-sellers seeking to cover bets a Microsoft deal was off.

8220;Even the rumor that Microsoft is getting interested again is enough to have people to want to cover their bets against Yahoo stock,8221; Squali said, adding that many investors have shorted Yahoo from the high 20s all the way down below 20.

Adding to the volatility were options investors who placed fresh bets Yahoo would be trading up to 27.50 by October, said analyst Rebecca Engmann Darst of Interactive Brokers Group.

THE WAITING GAME

Several financial analysts said a key detail in the Journal report was that Microsoft and Yahoo executives had sought to revisit the merger on May 17 8212; two weeks after Microsoft walked away 8212; and that two Yahoo board members in the meeting had said they would settle for a merger worth 33-34 a share.

On May 3, Yahoo rejected a 33-a-share Microsoft offer worth 47.5 billion, and earlier this week questioned whether the software maker was ever serious about a full-scale merger.

The source familiar with Microsoft8217;s thinking confirmed that Yahoo had belatedly sought a deal in mid-May worth 33 to 34, but that Microsoft was no longer interested at that point.

The source said Microsoft executives considered the early May deadline as vital to winning regulatory approval before the end of the year 8212; when a new presidential administration arrives and months more delays would likely occur.

Microsoft also become convinced that Yahoo executives were passively resisting the deal and unwilling to seriously negotiate. Meanwhile, the economy has taken a toll on the online ad market, and with it, the value of buying Yahoo.

8220;Microsoft is going to let Icahn do the dirty work and hand Yahoo over to them,8221; Jefferies 038; Co8217;s Squali said, adding that it was in Microsoft8217;s interest to hang back and let Yahoo shares settle lower as investors quit betting on a takeover premium.

In the long run, however, Microsoft needs Yahoo more than Yahoo needs Microsoft, he argued.

8220;Microsoft has a gaping hole in its strategy and it8217;s called the Internet and it8217;s only getting worse because Google is encroaching on Microsoft8217;s business,8221; Squali said.

Separately, the US Justice Department is pursuing a formal antitrust investigation into a deal reached last month between Yahoo and Microsoft-archrival Google Inc to team up on Web search advertising.

Google, with more than 60 per cent of the Web search market, and Yahoo, with 16.6 per cent, agreed to a deal for Google to run search ads on Yahoo8217;s site in a partnership that could mean 250 million to 450 million in new cash flow for Yahoo.

Google said it was confident the deal would enhance overall industry competition, but declined to discuss the probe.