Executives of AOL, the internet arm of Time Warner, met for formal talks with Microsoft yesterday afternoon to discuss a $40 billion (£20.02 billion) break-up of Yahoo!, the internet search engine, it has emerged.

It is understood that the AOL team flew to Microsoft’s headquarters in Seattle to negotiate possible terms of a break-up that could see the software giant seize control of Yahoo!’s online search business. The talks, thought to be preliminary, precede Yahoo!’s annual meeting on August 1, when the activist billionaire shareholder Carl Icahn will seek to oust the board.

Yahoo! insiders insist that an offer that sought to break up the company would not work because of difficulty in valuing its non-search business.

As reports of the talks leaked out to Wall Street yesterday, shares in all three companies surged on hopes that some deal might be done. Shares in Yahoo! and Microsoft both leapt by 4 per cent. Time Warner rose 5 per cent.

Yahoo!’s stock — which traded at $22.48 yesterday — is well below the $33 a share that was offered for the company by Microsoft in May.

Microsoft has been trying to buy Yahoo! for the past 18 months. At the end of January this year, Microsoft offered to pay $31 a share in cash and Microsoft stock for Yahoo! in a move that would have valued the internet search engine at $42 billion. The offer was rejected as too low. Microsoft returned with a raised offer of $33 a share — or $5 billion more — and that too was rejected, despite representing a 72 per cent premium to Yahoo!’s share price. Last week, Yahoo! rejected another offer from Microsoft and Mr Icahn.

Microsoft wants to buy Yahoo! so that it can better compete with Google, the world’s largest internet company, to grab a bigger share of an online advertising market estimated to be worth about $40 billion a year and expected to double by 2010.

After the two companies walked away from talks, Mr Icahn acquired a 4 per cent stake in Yahoo! and tried to force Microsoft and Yahoo! to restart discussions. He is angry that Yahoo!’s directors, led by Jerry Yang, its co-founder, refused to allow shareholders to vote on whether to accept any deal.

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