Deal or no deal?

(Fortune Magazine) -- Yahoo must have a new appreciation of how Burger King feels about McDonald's: Constantly looking up at No. 1 gets vexing. So it should come as no surprise that Yahoo's chairman and CEO Terry Semel is mulling a number of moves that would impress Wall Street and steal the spotlight from the Google (Charts) behemoth.

FORTUNE has learned from multiple sources that Yahoo (Charts) recently approached Time Warner (Charts) (parent of FORTUNE's publisher) about buying America Online - essentially trying to jump-start talks that broke down a year ago.

A source close to Yahoo disputes that Yahoo approached Time Warner and says that there are no active conversations between the two companies. Regardless of which version is correct, a Yahoo-AOL merger would be a face-saver for Semel: Last year Google outflanked Yahoo and swooped in to become AOL's exclusive Internet search provider, picking up a 5% stake in AOL for $1 billion as part of the deal.

If AOL rebuffs him, Semel has other dealmaking options. The 63-year-old former co-chairman and co-CEO of Warner Bros. has a considerable checkbook available for acquisitions. (Yahoo's market value is $35 billion, and it has about $3 billion in cash and securities.) A Yahoo purchase of youth-oriented Facebook for as much as $1 billion has been rumored for weeks. Semel could also sell his company. Microsoft (Charts) and others would love to own the web's biggest single audience. So, too, would Google - if only to keep Yahoo away from Microsoft.

What's killing Yahoo is the status quo. Google's dominance in search gives it a commanding lead in Internet advertising. And after inking a string of deals that turned Yahoo around in the post-bubble days, Semel has missed out on recent Internet land grabs, including MySpace and YouTube. That lack of deal momentum - exacerbated by the delay of Yahoo's search-advertising system, code-named Panama - and decelerating revenue growth have pounded Yahoo's stock, which is down 35% on the year.

Here, as we see it, are Yahoo's likeliest moves:

Buy AOL. Swallowing AOL won't transform Yahoo, but would give it increased traffic and a shot in the arm for its search-advertising business. The real question is whether Time Warner wants to sell.

"Time Warner has a new strategy for AOL and is not contemplating any deals," says a company spokesman. Citigroup analyst Jason Bazinet estimates AOL is worth about $13 billion. Of course, Time Warner might demand more.

Sell to Microsoft. If Semel can't buy AOL, the best move for his shareholders may be to sell the company. Both Yahoo and Microsoft's MSN have struggled against Google to cash in on search advertising. Integrating Microsoft's codehead culture with Yahoo's Internet vibe would be problematic. But buying Yahoo would be a triumph for Microsoft, giving it a major beachhead in Silicon Valley. If such a merger were to occur, the combined Yahoo and MSN would have 2006 net revenues nearly equal to Google's expected $7 billion.

Merge with eBay. The two sites occupy different corners of the web, so they'd be complementary. Indeed, eBay (Charts) and Yahoo already are stitching together a comprehensive cross-selling initiative in the U.S., and each is wary of Google. The two have discussed mergers over the years, so there's a long history there. But however appealing it may be, an eBay-Yahoo merger appears unlikely, say people close to the two companies, precisely because of their vastly different focuses.

Stay the course. This is Yahoo's party line. Semel says that if Yahoo can do better at monetizing search ads and exploit new areas like ads on cellphones, videos, and social-networking sites, it will do just fine. "With the landscape changing, I am very, very excited about the opportunities for Yahoo," he told investors in mid-October, when Yahoo reported its disappointing third-quarter results. Let's see if Yahoo's board is as patient as Semel.

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