UPDATE 5-Microsoft proposes alternative deal to Yahoo

(Recasts with Icahn view from source, adds details, additional byline and New York dateline)

By Daisuke Wakabayashi and Dane Hamilton

SEATTLE/NEW YORK, May 18 (Reuters) - Microsoft Corp (MSFT.O: Quote, Profile, Research, Stock Buzz) said on Sunday it proposed an alternative deal to Yahoo Inc (YHOO.O: Quote, Profile, Research, Stock Buzz) rather than a full acquisition, but the move was unlikely to win favor with financier Carl Icahn, a person familiar with his thinking said.

Icahn launched a proxy campaign on Thursday to replace Yahoo's board with directors who would reopen talks with Microsoft, saying Yahoo had acted irrationally in refusing the giant software company's $47.5 billion bid.

Microsoft walked away from its pursuit of Yahoo two weeks ago after three months of negotiations when Yahoo's board rejected Microsoft's sweetened offer of $33 a share, saying the company was worth at least $37 a share.

The software giant's move on Sunday was likely to prompt the billionaire investor to press Yahoo to further pursue a possible alliance with Google (GOOG.O: Quote, Profile, Research, Stock Buzz), the source said.

"Microsoft is trying to get the milk without buying the cow, and if you look at Icahn's history, he has never been used that way," said this person. "He does not want to see Yahoo pushed into some joint venture with Microsoft and is not going to be used to push Yahoo into it."

Microsoft's statement on Sunday said it was "considering and has raised with Yahoo an alternative that would involve a transaction with Yahoo but not an acquisition of all of Yahoo." It did not clarify what that alternative might be.

The New York Times reported that Microsoft and Yahoo may form a partnership or joint venture for search-related advertising to take on Google Inc (GOOG.O: Quote, Profile, Research, Stock Buzz), which dominates the search market with a share significantly larger than a combined Yahoo and Microsoft.