AOL, the internet arm of Time Warner, has approached Microsoft about a possible tie-up as a deal between the software group and Yahoo! unravelled, The Times has learnt.

The move emerged as Microsoft this weekend said it was walking away from Yahoo!, after the online search engine rejected a second, higher offer from the software group valuing Yahoo! at $47.5 billion (£24 billion).

The news broke after a meeting in Seattle on Saturday at which Steve Ballmer, chief executive of Microsoft, sought to persuade Jerry Yang, co-founder of Yahoo, to yield to the software group by raising his offer from $31 a share to $33. The increased offer valued Yahoo! at $5 billion more than Microsoft’s initial approach in February. Mr Yang refused to accept the increased valuation, insisting that Yahoo shares were worth at least $38.

In a letter to Mr Yang, Mr Ballmer said: “I am disappointed that Yahoo! has not moved towards accepting our offer ... I still believe even today that our offer remains the only alternative put forward that provides your stockholders full and fair value for their shares. By failing to reach an agreement with us, you and your stockholders have left significant value on the table. But clearly a deal is not to be.”

Microsoft wanted to buy Yahoo! to win a bigger slice of the online advertising market, valued at $40 billion a year and set to double within two years. A combination of Yahoo! and Microsoft would have helped the software group to compete more effectively with Google, the world’s biggest internet company.

It emerged yesterday that Microsoft has been approached by a number of the parties with which Yahoo! had sought a defensive tie-up to fight off Microsoft. It is understood that AOL, the internet arm of Time Warner, is one of those companies.

At the same time, it is also understood that Yahoo! is continuing talks with both News Corporation, parent company ofThe Times, and with AOL, in an attempt to forge an alliance to compete more effectively with Google. Having rejected a $33-a-share offer, Mr Yang is now under pressure to devise a means of boosting the online search engine’s share price and justifying his board’s rejection of the offer.

After a three-month fight for control of Yahoo!, Microsoft decided to walk away after Mr Yang threatened to forge an alliance with Google.

In his letter to Yahoo!, Mr Ballmer said: “Our discussions with you have led us to conclude that, in the interim, you would take steps that would make Yahoo! undesirable as an acquisition for Microsoft. We regard with particular concern your apparent planning to respond to a ‘hostile’ bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid internet search terms offered by Yahoo! today. In our view, such an arrangement with the dominant search provider would make an acquisition of Yahoo! undesirable to us.”

Sir Martin Sorrell, chief executive of WPP, the advertising group, told The Times yesterday: “Microsoft showed price discipline by not going above their revised offer. You don’t need to worry about Microsoft, they are a $300 billion company with plenty of other ideas to explore. The people who have lost out most are their customers and [advertising] agencies who were looking for a better balance in the marketplace. Such a deal would have provided that balance.”

Roy Bostock, chairman of Yahoo!, said: “We remain focused on maximising shareholder value and pursuing strategic opportunities that position Yahoo! for success and leadership in its markets. From the beginning of this process, our independent board and our management have been steadfast in our belief that Microsoft’s offer undervalued the company and we are pleased that so many of our shareholders joined us in expressing that view.”

Microsoft and Yahoo! both declined to comment and Time Warner failed to return calls.

Explore Markets

• United States

• Europe

• Japan

• China

• Russia

• The Gulf

• India

• Africa

Times Recommends

• Bank on the brink as recession fears worsen
• Persimmon takes housing sector job cuts to 4,500
• Savills hit as London house prices down 7.5%