Yahoo! (YHOO) in merger talks with Time Warner (TWX) AOL

Yahoo! (NASDAQ: YHOO), still trying to prevent a deal in which it would be taken over by Microsoft (NASDAQ: MSFT), has stepped up talks with Time Warner (NYSE: TWX) about merging AOL into the big portal company. According to The Wall Street Journal, "the Time Warner talks have stepped up as Yahoo tries to nail down its alternatives to Microsoft's Feb. 1 offer, which Yahoo rejected as undervaluing it. The scenario under discussion would involve folding AOL into Yahoo with Time Warner taking a sizable minority stake in the combined entity."

Although the combination would create an internet company with an audience much larger than Microsoft's or Google's (NASDAQ: GOOG), it is not clear that Yahoo!'s shareholders would find it an acceptable alternative to the deal with Redmond. The offer of a fixed $31 is much high than the $19 where Yahoo! traded just a few weeks before the takeover was proposed.

The combination would not create a challenge to Google in the search business. AOL's search market share is generally put at about 5% of the US internet population. Search revenue is viewed as a faster growing category than display advertising, where Yahoo! and AOL do well. Microsoft and Yahoo! together would have about 30% of the search market in America. Google has over 60%.

Although combining AOL and Yahoo! would allow some redundant costs to be taken out, both companies are experiencing slow ad revenue growth. Putting the two companies together won't solve that.

The deal won't work for the Yahoo! board, already under pressure to take the $31 from Microsoft and run.

Douglas A. McIntyre is an editor at 247wallst.com.