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Microsoft and Yahoo! have entered "early discussions" on a possible search and advertising partnership, including a face-to-face meeting between new Yahoo! chief executive Carol Bartz and Microsoft boss Steve Ballmer.

Citing "several sources with knowledge of the situation", All Things Digital has reported the two Google chasers are discussing a wide range of potential agreements but have stopped short of resurrecting the idea of Microsoft actually acquiring all or part of Yahoo!.

In February, Steve Ballmer bid $31 a share for Yahoo!, and when Yahoo! and then CEO Jerry Yang turned him down, he went to $33 a share - a $47.5bn offer. But Yang turned that down too. Then he turned down a separate bid for Yahoo!'s search biz.

After Wall Street kingpin Carl Icahn launched a Yahoo! proxy battle in an effort to force a Microsoft deal, Yang and Co. inked an ill-fated search ad pact with arch rival Google, the world's number-one ad broker. Google ultimately backed out of the deal after the US justice department threatened to sue.

Carl Icahn now has a seat on the Yahoo! board. Yang has returned to his role as "Chief Yahoo!" and it appears that Bartz is ready to patch things up with the Microsoft Borg.

One possible pact, sources told All Things Digital, would involve Yahoo! taking over Microsoft's display business and Redmond running search for the two companies.

Microsoft has already pinched Yahoo! search guru Qi Lu, and it's set to launch a new search engine based on technologies it acquired after gobbling San Francisco startup Powerset. But of late, Yahoo! has made a greater effort to suck additional dough from its own search engine. Among other things, the company uses search logs to target display ads.

And Yahoo! search has made mini-resurgence of late. According to preliminary numbers from AdGooroo, Yahoo! saw a 10 per cent increase in first-result-page advertisers in the first quarter of the year, grabbing an extra four per cent of the search ad market from Microsoft.

In announcing its fourth quarter numbers in January, Yahoo! welcomed Bartz with a $303m loss. But if you exclude severance packages tossed at departed Yahooligans and write-downs involving a few international assets, the quarter was profitable.

Display revenue was down for the quarter. But the company's worldwide search revenue grew 11 per cent, with US dollars jumping 18 per cent. US queries were up more than 10 per cent. Yahoo! announces its first-quarter numbers on April 21. ®

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