Murdoch may team up with Microsoft in bid for Yahoo

SAN FRANCISCO — Rupert Murdoch's News Corp. is in talks with Microsoft about joining in its contested bid for Yahoo, according to people involved in the discussions. The pairing, which would combine Yahoo, Microsoft's MSN and News Corp.'s MySpace, would create a behemoth that would upend the Internet landscape.

The talks are a surprising twist in the two-month-long takeover story that began when Microsoft made a $44.6 billion bid for Yahoo.

Yahoo has resisted Microsoft's overtures, contending that it will not negotiate unless Microsoft raises its offer. Yahoo, which wants to remain independent, has been in a desperate search for white knights, holding conversations with Time Warner's AOL and News Corp.

The Wall Street Journal reported Tuesday evening that Yahoo is in talks with AOL to combine their Internet operations, citing people familiar with the situation.

If that deal moved forward, Time Warner would take a 20 percent stake in Yahoo and make a cash investment; Yahoo would then buy back billions of dollars of its own stock at a price between $30 and $40 a share, the newspaper said.

If News Corp. throws its weight behind Microsoft's offer, it could allow Microsoft to raise its bid, putting even more pressure on Yahoo and its shareholders. At the same time, the alignment of Microsoft and News Corp. would remove a possible alternative for Yahoo, leaving it with fewer opportunities to escape Microsoft's grasp.

The talks between Microsoft and News Corp. are at a sensitive stage, people involved in the discussions said. "There's a long way to go before anything is definite," one person involved in the talks said.

A Microsoft spokesman said he could not immediately comment. A spokesman for Yahoo declined to comment. A News Corp. spokesman said the company does not comment on "speculation."

It was possible that News Corp. could still participate in a deal with Yahoo, though the disclosure of its talks with Microsoft might complicate that relationship.

Terms of the proposed union are still being worked out and remain murky, these people said. News Corp. would probably contribute its Fox Interactive Media unit, which includes MySpace, and possibly cash to Microsoft as part of an acquisition of Yahoo, they said.

The talks represent a change of sides for Murdoch. Just days after Microsoft made its bid for Yahoo, he flew to the West Coast and had dinner with Jerry Yang, Yahoo's chief executive, offering his assistance in fending off Microsoft. A deal between them would have involved joining forces with Yahoo's archrival Google to use its lucrative advertising system on the companies' sites. However, antitrust concerns have all but scuttled those talks, at least in that form.

On Wednesday, Yahoo suggested that it was willing to cede part of its core business to Google to remain independent.

Yahoo said it would begin outsourcing a small portion of its search advertising to Google. The limited test is meant to determine whether the company could increase revenues if Google ran its search advertising system. The test results might also back Yahoo's contention that Microsoft's offer undervalued the company, a person briefed on the plan said.

During the two-week test, Yahoo will use Google's search advertising system, called AdSense for Search, to deliver ads that appear alongside Yahoo's search results. The test will involve searches conducted in the United States on Yahoo.com, not on any of the company's search affiliates, and will be limited to no more than 3 percent of all search queries, Yahoo said in a statement.

Microsoft immediately blasted the idea of a search advertising partnership between Yahoo and Google, saying it would be anti-competitive. "Any definitive agreement between Yahoo and Google would consolidate over 90 percent of the search advertising market in Google's hands," Microsoft said in a statement.

In Washington, Sen. Herb Kohl, D-Wis., the chairman of the Senate Judiciary Committee's Subcommittee on Antitrust, Competition Policy and Consumer Rights, also warned about the potential anti-competitive implications. "We will be following closely the results of the short-term test alliance between Yahoo and Google," he said in a statement. Kohl had previously raised concerns about a Microsoft-Yahoo combination.

Yahoo's board is expected to meet this week to discuss its options.

For Yahoo, the idea of outsourcing search advertising to Google is not new. Investors and some executives inside the company have long recommended that it do so, as it could help the company increase revenue and cut costs.

Yahoo executives have resisted the idea, saying that search was an essential piece of the company's business. Yet in a presentation to investors last month, Yahoo estimated that Google's search advertising generated 60 percent to 70 percent more revenue on average than Yahoo's.

Eric E. Schmidt, Google's chief executive, also offered his assistance to Yahoo soon after Microsoft announced its offer. Executives from the two companies held talks to discuss, among other things, a search advertising partnership, but those talks cooled.

The talks appeared to have heated up again recently. Yang and Yahoo's president, Susan Decker, visited Google in the past two weeks, said a person briefed on their visit.

The advertising test may be a way for Yahoo to show Microsoft that it still has alternatives, said Carl W. Tobias, a law professor at the University of Richmond in Virginia. "But if this were to go forward as a full proposal, there would be some serious concerns in the antitrust area," Tobias said.