Yahoo rejects Microsoft's advances and seals advertising deal with Google

The on-again, off-again talks between Microsoft and Yahoo appeared last night to have irrevocably broken down after Yahoo rejected an offer for its search advertising business and instead signed an alliance with its arch-rival, Google.

Walking away from negotiations, Yahoo said it had asked Microsoft to revive its $46bn (£23.6bn) takeover for the whole company, only to be told that the software giant was no longer interested.

Yahoo shareholders are threatening a revolt after the internet pioneer rejected Microsoft's full takeover bid last month, but hopes that new talks could still create a powerful new player to rival Google appeared in tatters last night.

Instead, Google said it would start selling adverts to appear alongside search results on Yahoo's website – a move which Microsoft is certain to ask competition authorities to scrutinise.

Google has already cornered 60 per cent of that market, compared to 10 per cent for Microsoft's MSN business and around 20 per cent for Yahoo.

In an attempt to forestall criticism, Google said Yahoo's move to outsource its search advertising was akin to General Motors using Toyota's hybrid technology, which does not lessen the ferocity of competition in the car industry. Google will also not be able to raise prices for advertisers, as prices are set by an auction.

Yahoo shares plunged 10 per cent on news of an end to negotiations with Microsoft, closing at a level almost $10 below the $33 per share that Microsoft had offered for the company last month. Yahoo's founder and chief executive, Jerry Yang, had at that point been holding out for $37 or $38. The latest talks – when Microsoft asked to buy just the Yahoo search business – were undertaken by other board members and did not involve Mr Yang, it is understood.

Yahoo shareholders erupted in fury after Mr Yang sent Microsoft packing last month, and Carl Icahn, the billionaire investor, is launching an attempt to replace the entire Yahoo board at its shareholder meeting in August. Other investors are suing.

The sale of its search-based advertising business alone was undesirable, it said last night, since there are too many synergies with its other advertising business, which sells banner ads, pop-ups and commercial video on Yahoo and its partners' websites.