April 10 (Bloomberg) -- Yahoo! Inc. is close to an agreement to combine operations with Time Warner Inc.'s AOL unit in a bid to fend off Microsoft Corp.'s $44.6 billion takeover offer, a person familiar with the situation said.

Yahoo would gain control of AOL, receive an investment from Time Warner, and give up a 20 percent stake in the combined entity, said the person, who asked not to be identified because the talks aren't public. The investment would let Yahoo buy back billions of dollars of its own stock, the person said.

Chief Executive Officer Jerry Yang is racing to find alternatives to Microsoft's $31-a-share bid as the prospect of a proxy battle looms. Yesterday, Yahoo said it would display some Web search advertising links sold by Google Inc., a move that may give Yahoo more time to convince investors it can remain an independent company.

``This is a move toward an independent future, but investors will not be impressed,'' said Wim Zwanenburg, who helps oversee the equivalent of $43 billion at Bank Degroof Group, including Microsoft shares. ``This is going to be an enormous fight in which Microsoft will prevail.''

Diana Wong, a spokeswoman for Sunnyvale, California-based Yahoo, didn't return a call for comment. Time Warner spokesman Ed Adler declined to comment.

`Rumble in the Jungle'

``There will be more rumble in the jungle,'' said Juergen Lukasser, who helps manage the equivalent of about $20 billion as head of equities at Constantia Privatbank AG in Vienna. Constantia holds Microsoft shares, but no Yahoo stock. ``Microsoft will have to raise its bid.''

The talks with AOL and Google, owner of the most-used Internet search engine, indicate that Yang, 39, is making progress two months after telling investors that the company is seeking alternatives to Microsoft's bid. Microsoft's offer was 62 percent higher than Yahoo's closing price the previous day.

``They're delay tactics,'' Laura Martin, an analyst at New York-based Soleil Securities Corp., said of Yahoo's actions. She rates Yahoo shares ``hold'' and doesn't own any. ``They're just going to irritate Microsoft and accelerate a proxy fight.''

News Corp. Interest

Separately, the New York Times reported that News Corp. is in talks to join Microsoft's bid for Yahoo, citing people involved in the discussions. The deal would combine Yahoo, Microsoft's MSN and News Corp.'s MySpace, the newspaper said.

Microsoft spokesman Frank Shaw didn't return a call seeking comment. Teri Everett, a spokeswoman for New York-based News Corp., said the company doesn't comment on ``speculation.''

Yahoo, owner of the most-visited U.S. Web site, rose 2 percent to the equivalent of $28.32 as of 11:07 a.m. in German trading from the close of $27.77 yesterday on the Nasdaq Stock Market. After jumping 48 percent on Feb. 1, the day after Microsoft's bid, the stock declined 2.1 percent before today.

Time Warner, the world's largest media company, fell 4 cents to the equivalent of $14.39 in Germany from $14.43 in New York Stock Exchange composite trading yesterday. Before today, shares of the New York-based company had declined 13 percent this year.

Microsoft fell 2 cents to the equivalent of $28.87 in German trading from yesterday's close in the U.S.

Challenging Google

``Yahoo is a very attractive company and going forward, I think they could benefit from cooperation with other Internet companies,'' said Yasuhiko Hirakawa, who manages $80 billion of assets at DIAM Co. in Tokyo, including Yahoo shares. ``Consolidation is definitely a trend for the Internet.''

Microsoft CEO Steve Ballmer is pursuing Yahoo to challenge Google's dominance of the $41 billion online ad market. Ballmer, 52, said in an April 5 letter that Yahoo has three weeks to accept a deal or become the target of the company's first hostile takeover. Yahoo responded to Microsoft's threat of a proxy fight by insisting on a higher price.

``We continue to believe a Microsoft-Yahoo deal is the most likely outcome and continue to believe that it will happen at a higher price than the initial $31 bid,'' Citigroup Inc. analysts Mark Mahaney and Brent Thill wrote in a report today.

A combination with AOL would bring together the second and fourth most-used Internet search engines in the U.S. Google is the most popular, attracting 59.2 percent of queries in February, according to Reston, Virginia-based researcher ComScore Inc. Yahoo had 21.6 percent, followed by Microsoft with 9.6 percent and AOL with 4.9 percent.

``AOL has been a failure in the past five, six years,'' Bank Degroof's Zwanenburg said. ``Time Warner would be glad to get rid of it. It's a lame duck.''

The Wall Street Journal reported Yahoo's talks with AOL yesterday.

U.S. Trial

Unable to catch Google in search, Yahoo said it's starting a two-week trial in the U.S. to run its rival's ads alongside no more than 3 percent of search queries.

Yahoo and Google have been here before. In 2000, Yahoo chose Google as its default search engine, an agreement that lasted until Yahoo's then-CEO Terry Semel orchestrated the acquisitions of Inktomi Corp. and Overture Services Inc. to build a new search service.

Last year, Yahoo introduced an ad platform, called Panama, designed to make search ads more relevant and more likely to be clicked. In a presentation to investors last month, Yahoo said it had reduced the gap in revenue per search between its own engine and Google's in the U.S. by 30 percent in the first nine months of 2007. At the end of last year, a difference of 60 percent to 70 percent still existed, the company said.

Regulatory Review

While a partnership with Google may cut Yahoo's costs, a deal would face stiff regulatory scrutiny. Senator Herb Kohl, a Wisconsin Democrat, said yesterday that the Senate Judiciary Committee, which he chairs, would examine any formal agreement to ``ensure that it does not harm competition.'' Microsoft echoed that possibility after the announcement.

``Any definitive agreement between Yahoo and Google would consolidate over 90 percent of the search advertising market in Google's hands,'' Microsoft General Counsel Brad Smith said in a statement. ``This would make the market far less competitive, in sharp contrast to our own proposal.''

To contact the reporter on this story: Ari Levy in San Francisco at alevy5@bloomberg.net

Last Updated: April 10, 2008 05:16 EDT