Yahoo, AOL close in on tie-up deal

Updated: 2008-04-10 09:54

Yahoo Inc. and Time Warner Inc.'s AOL are closing in on a deal to combine their Internet operations, a move that could thwart Microsoft Corp.'s effort to acquire Yahoo, people familiar with the matter said Wednesday.

The possible Yahoo-AOL tie-up is part of a threefold plan by Yahoo to present shareholders with an alternative to Microsoft's unsolicited offer. Yahoo would also propose repurchasing billions of dollars of its own shares and is negotiating with Google Inc. about an advertising tie-up. On Wednesday, Yahoo announced a short-term test under which it will carry search advertising from Google.

Pedestrians walk past the Time Square Yahoo sign in New York April 7, 2008. [Agencies]

At the least, Yahoo's plan may give it more leverage to negotiate a higher price from Microsoft. However, Yahoo might have difficulty convincing its shareholders that a Yahoo-AOL combination is attractive. Microsoft has threatened to take its offer directly to shareholders via a proxy fight.

If consummated, the Yahoo-AOL discussions would unite two of the Internet's largest Web sites. One person involved in the discussions cautioned that there was still "a lot of work to do" before a final agreement between AOL and Yahoo. Yet there is also incentive for Time Warner to complete a deal. It has been struggling to find a viable strategy for AOL for years. AOL has lost most of its value since it combined with Time Warner in 2000.

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Under the terms being discussed, Time Warner would fold its AOL unit into Yahoo and make a cash investment in return for about 20% of the combined entity, the people said. The deal, which wouldn't include AOL's dial-up access business, would value AOL at about $10 billion. As part of the deal, Yahoo would use the Time Warner cash and additional funds to buy back several billion dollars worth of its own stock at a price somewhere in the middle of the range between $30 and $40 a share, the people said. Any deal would be taken to Yahoo shareholders for approval, the people said.

Microsoft has offered Yahoo shareholders a combination of cash and Microsoft shares currently valued at $42 billion, or $29.24 a share. Many analysts and investors believe that Microsoft will ultimately wind up acquiring Yahoo with a sweeter bid. Yahoo shares closed at $27.77, up seven cents, or 0.25%, in 4 p.m. trading on the Nasdaq Stock Exchange Wednesday.

The announcement of the Yahoo-Google test Wednesday turns up the pressure on Microsoft. A tie-up between Yahoo and AOL is not contingent on the success of the test, people close to the discussions said. Google already handles search advertising sales for AOL and owns a 5% AOL stake.

Yahoo and AOL are broadening their businesses to sell online advertising across other Web sites. Such efforts are in part a recognition that much of the growth momentum online has passed to younger players such as Facebook Inc.'s social-networking site and Google's YouTube video-sharing service.

Responding to such trends, Microsoft wants to combine with Yahoo to better challenge Google. Microsoft Chief Executive Steve Ballmer, in a letter Saturday, gave Yahoo directors three weeks to reach a friendly deal before Microsoft would go hostile, implying that Microsoft would lower its bid in that case.

Yahoo's directors have rejected Microsoft's current offer as too low. In a letter Monday responding to Mr. Ballmer, they called his ultimatum "counterproductive."

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