Microsoft has proposed to buy Yahoo's search business and take a minority stake in the Web pioneer, stopping short of a full-out merger, a person familiar with the discussions said on Monday.
As part of the deal Yahoo would put its Asian assets, including significant minority stakes in Yahoo Japan and China's Alibaba Group, up for sale, while Microsoft would buy a chunk of what remains of the company, the source said.
The talks were revealed by the two companies on Sunday, but they declined to reveal the terms of the discussions. Earlier this month, Microsoft walked away from a proposal to acquire Yahoo for $47.5 billion, or $33 per share, after Yahoo rebuffed the offer, saying it would only settle for $37 a share.
The new deal, if completed, would forge an alliance between the two companies that would represent an alternative means of competing with rival Google , whose ubiquitous search engine has made it an online advertising powerhouse.
The proposal represents an outline of Microsoft's current thinking and it does not yet put a value on Yahoo's search business, said the source, who was not authorized to speak on the record because the discussions are confidential.
Microsoft and Yahoo representatives declined to comment.
Collins Stewart analyst Sandeep Aggarwal estimates Yahoo's search advertising business is worth about $21 billion, while putting the value of its its international assets at $9.25 billion, according to a research note he published on Monday.
"Microsoft is the most interested in Yahoo Search," said Aggarwal, who added that Microsoft may buy parts of Yahoo for a premium or buy all of Yahoo and then spin off certain assets.
Shares in both Yahoo Japan and Alibaba.com dropped 4 percent on the new proposal, thanks to the greater uncertainty now hanging over the two companies.
"We had always looked at Yahoo Inc teaming up with Microsoft as a positive for Yahoo Japan," said Macquarie Securities analyst Nathan Ramler.
"The fact that Yahoo Japan is potentially not included is a concern," he said, adding that the Japanese company could have benefited from Microsoft's expertise in software, personal computers and its deep pockets.
Microsoft said on Sunday that it was talking with Yahoo about an alternative transaction that did not involve a full buyout after withdrawing its sweetened $47.5 billion bid for the company on May 3.
Yahoo is a distant second to Google in Web search in the United States, and Microsoft is third.
Combined, Yahoo and Microsoft would have around a 30 percent US share, compared with Google's roughly 60 percent, according to figures from research firm comScore. Google's lead is even larger on a global basis, according to comScore.
The proposal from Microsoft would likely complicate ongoing discussions between Yahoo and Google. The two companies are still talking about a possible search advertising partnership, people familiar with those discussions have told Reuters.
Talks between Yahoo and Microsoft resumed after Microsoft insisted for two weeks that it had moved on from its pursuit of Yahoo, prompting shareholders of the Web company to criticize its board for mishandling negotiations.
Financier Carl Icahn launched a proxy fight last week to force Yahoo to reopen talks with Microsoft. Icahn, who owns nearly 10 million Yahoo shares as well as options to acquire another 49 million shares, formally filed on Monday the preliminary proxy to nominate 10 directors to Yahoo's board.
A person familiar with Icahn's thinking said on Sunday that an alternative deal for Yahoo, rather than a full acquisition, would prompt the investor to push Yahoo to do a deal with Google.
Icahn did not comment on the talks between Microsoft and Yahoo in his filing on Monday.
For its part, Alibaba Group, the private holding company whose assets include Alibaba.com, has been lining up investors to help it buy back the Yahoo stake, sources told Reuters earlier.
Yahoo's core franchise stems from the roughly 500 million Web users who pass through its network of Internet media properties each month. Major attractions include Yahoo Mail, news, sports, entertainment and its Flickr.com photo site.
It generates most of its revenue through sales of display advertising to those visitors, as well as making an increasing push to sell ads on non-Yahoo sites. As the No. 2 provider of Web search services, Yahoo also sells ads alongside search results and on a variety of affiliated sites.