Rejected Microsoft-Yahoo deal worth $9.5bn

The proposal also included a revenue-sharing partnership that would have delivered $US1 billion a year in additional operating income to Yahoo due in part to a three-year guarantee of better rates for advertisements tied to its search results than Yahoo's current Panama advertising system.

Microsoft's most recent offer was an alternative to its previous full acquisition proposal. Instead, Yahoo entered an advertising agreement with Google on Thursday.

Microsoft, a dominant force in desktop software but a laggard in online search advertising, is still open to discussing its alternative proposal despite Yahoo's partnership with Google, a source familiar with Microsoft's thinking said.

Yahoo had no comment. Microsoft spokesman Jeff O'Mara declined to comment.

Another source familiar with the matter said Microsoft had proposed a 10-year exclusive deal to handle Yahoo's search advertising and only guaranteed higher advertising rates for three of those years.

Mr Johnson's email did not mention the duration of the deal, only saying it was "long term".

By contrast, Yahoo's deal with Google, which will pit the two companies' ads against each other in an auction, is non-exclusive. It means other companies can join in the auction to bid to place ads next to Yahoo's search results.

"Unfortunately Yahoo has chosen a different course, and yesterday announced an agreement that would start to consolidate over 90% of the paid search advertising market in Google's hands," said Mr Johnson in the email.

"This will make the market far less competitive."

The deal with Google would boost Yahoo's cash flow by $US250 million to $US450 million in the first 12 months, according to Yahoo. It would be less than half of Microsoft's forecast for $US1 billion in additional operating income, the source familiar with Microsoft's thinking said.

Microsoft said its proposal would have delivered $US1 billion of incremental operating income to Yahoo because it would reduce Yahoo's operating costs for running search and the company would receive large payments in the form of so-called traffic acquisition costs from Microsoft.

Yahoo would also not have to make hefty research and development investments for search, Microsoft said.

"On the surface, it looks like a better deal," Gartner analyst David Mitchell Smith said of Microsoft's search deal proposal for Yahoo.

Mr Smith cautioned, however, that there may have been issues not revealed publicly that made the Google deal a better option.

Microsoft abandoned its offer to buy all of Yahoo in May as negotiations dragged on, making it unlikely that a deal could complete regulatory review during the Bush administration, the source said.

If the full acquisition could not get approval by year-end, the review process could have carried on until as late as October 2009, meaning that Microsoft would have to carry the capital risk of a $US40-billion-plus acquisition for 18 months.

It also became less interested in a full acquisition after Yahoo's search share continued to deteriorate more than Microsoft had forecast, the source said. A lucrative severance agreement put in place by Yahoo's management also made a full acquisition less appealing, the source said.

Microsoft structured its alternate proposal to focus solely on search to take into account Yahoo's concerns that combining the two companies' email and instant messaging users would not gain regulatory approval, the source said.