Plans for Microsoft and Yahoo to take on Google

Alliance would open up internet search market

Yahoo executives are to be questioned today on reports that they may be ready to set aside their differences with Microsoft and make an alliance against a common enemy: Google.

While Google continues to dominate the internet search market – and harvest the majority of the revenues from ads placed alongside search results – a new chief executive at Yahoo and a new search engine from Microsoft, the well-received Bing, have changed the dynamics of the negotiations between the two companies.

The two sides are in the final stages of talks about a deal that could see Microsoft take over the running of Yahoo's search-based advertising business, in return for guaranteed payments to Yahoo. The shape of the deal is still unclear, however, and analysts are nervous that the negotiations could still break down.

Yahoo's second-quarter financial results are due after the close of trading today, and Microsoft reports its latest figures on Thursday, giving an opportunity for investors to question executives at both companies – even if a deal is not sealed in time to be announced.

Youssef Squali, an analyst at Jefferies & Co, is recommending investors buy Yahoo shares, even though current results will be muted by the advertising recession. He raised his price target on the shares by 5 per cent yesterday, citing, among other things, the potential for profits from the Microsoft alliance. Todd Lowenstein, a fund manager at HighMark Capital, said: "The sooner these two decide to bring the best of what they both have together and then jointly go after the market, the more it will benefit both."

In rancorous, on-again-off-again talks over the course of almost 18 months, Microsoft repeatedly tried to buy Yahoo, finally offering $46bn for the company last year, only to be turned down by its founder and then-chief executive Jerry Yang. A later attempt to tie up an advertising alliance also collapsed, as Yahoo agreed to outsource its search-based advertising business to Google, only to find that deal scuppered over competition concerns.

Carol Bartz, who took over as Yahoo's chief executive in January, has signalled she is more open to a Microsoft alliance and has met on several occasions with Steve Ballmer, her opposite number at Microsoft. Last week, several senior Microsoft executives are understood to have flown to Silicon Valley to meet Yahoo counterparts to try to hammer out a deal.

The launch of Bing by Microsoft has helped it claw a little market share away from Yahoo. According to ComScore, Microsoft's share of search queries rose to 8.4 per cent in June from 8 per cent the previous month, while Yahoo fell to 19.6 per cent. Sixty-five per cent of search queries go through Google.

The activist investor Carl Icahn, who bought into Yahoo last year to agitate for a sale to Microsoft, is putting on more pressure for an alliance. "I've been a strong advocate of getting a search deal done with Microsoft," he said. "It would enhance value if a deal got done, because of the synergies involved."

Yahoo shares are half the value of Microsoft's takeover offer. Microsoft is expected to report the first annual sales dip as a public company on Thursday, but the signs of a tie-up with Yahoo and a strong pipeline of new products have pushed its shares up 63 per cent since early March. It has begun trailing the launch of a Windows 7 operating system, and has a new version of its Office applications suite in the works.