By Daisuke Wakabayashi and Dane Hamilton

SEATTLE/NEW YORK (Reuters) - Microsoft Corp said on Sunday it proposed an alternative deal to Yahoo Inc rather than a full acquisition, but the move was unlikely to win favor with financier Carl Icahn, a person familiar with his thinking said.


Icahn launched a proxy campaign on Thursday to replace Yahoo's board with directors who would reopen talks with Microsoft, saying Yahoo had acted irrationally in refusing the giant software company's $47.5 billion bid.

Microsoft walked away from its pursuit of Yahoo two weeks ago after three months of negotiations when Yahoo's board rejected Microsoft's sweetened offer of $33 a share, saying the company was worth at least $37 a share.

The software giant's move on Sunday was likely to prompt the billionaire investor to press Yahoo to further pursue a possible alliance with Google , the source said.

"Microsoft is trying to get the milk without buying the cow, and if you look at Icahn's history, he has never been used that way," said this person. "He does not want to see Yahoo pushed into some joint venture with Microsoft and is not going to be used to push Yahoo into it."

Microsoft's statement on Sunday said it was "considering and has raised with Yahoo an alternative that would involve a transaction with Yahoo but not an acquisition of all of Yahoo." It did not clarify what that alternative might be.

The New York Times reported that Microsoft and Yahoo may form a partnership or joint venture for search-related advertising to take on Google Inc , which dominates the search market with a share significantly larger than a combined Yahoo and Microsoft.

For its part, Yahoo continues to talk with Google Inc about a search advertising partnership and a deal could come as early as this week, a source familiar with the talks said on Thursday.

Microsoft emphasized it was not proposing to make a new bid to buy all of Yahoo, after recently being rebuffed, but could reconsider.

Yahoo replied later on Sunday that it continued to consider a number of strategic alternatives and was "open to pursuing any transaction which is in the best interest of our stockholders."

The company's board will "evaluate each of our alternatives, including any Microsoft proposal, consistent with its fiduciary duties, with a focus on maximizing stockholder value," Yahoo said in a statement.

It added it had confirmed with Microsoft that it was not interested in "pursuing an acquisition of all of Yahoo at this time."

ANALYSTS SPLIT

Analysts were split on the benefits of an alternative scenario to a full-fledged takeover.

"I definitely think an alternative deal is better than a full acquisition," said Toan Tran, analyst at Morningstar. "It is positive for both companies, because you are getting the benefits of a Yahoo acquisition without the negatives, namely the integration risks."

But Kim Caughey, a senior analyst at Fort Pitt Capital Group, said the market will probably send Yahoo shares higher while pushing down Microsoft shares when the market opens on Monday.

Caughey said a joint venture or minority investment with Yahoo could cause confusion about who was in charge.

"Microsoft walking away from Yahoo was a total head fake," said Caughey. "Microsoft is a terrible poker player if it thought people were going to believe that the deal was dead."

Meanwhile, Microsoft and Icahn have not held discussions about Yahoo, said another source close to the company.

In a letter to Icahn last week, Yahoo board Chairman Roy Bostock said a new board would not be in the best interests of Yahoo investors, adding Yahoo would consider any deal from any party, including Microsoft, if it offered the company full value.

Icahn, who has said he had accumulated 59 million shares and options in Yahoo, also has the support of Paulson & Co, a $30 billion hedge fund that has amassed a 3.4 percent stake in Yahoo, and other investors upset by the board's handling of negotiations with Microsoft.

(Additional reporting by Megan Davies in New York, Anupreeta Das and by Sinead Carew; Editing by Gerald E. McCormick and Anshuman Daga)
© Copyright 2007 Reuters.