Advisers from Time Warner-owned AOL have held talks with representatives of Yahoo to see if a deal is workable, the Sunday Telegraph reported.

Microsoft has offered to buy Yahoo for more than $40bn (£20.5bn).

But AOL is thought to be keen on being the firm that helps Yahoo avoid falling into Microsoft's cl**tches.

Last week Rupert Murdoch's News Corporation was said to have taken an interest in merging its online interests - which include MySpace - with Yahoo.

'Walk away'

Yahoo has dismissed Microsoft's $31-a-share offer as undervaluing its brand, audience, investments in advertising platforms and future growth prospects, free cash flow and earnings potential.

And according to a separate report, an influential Microsoft investor has called on the software giant to walk away from the Yahoo offer.

Robert Olstein, a fund manager with about one million Microsoft shares has written to the firm saying that it should "in no circumstances" raise its offer.

He, like many other investors, believes that buying Yahoo would prove a distraction to Microsoft, the Observer said.

Microsoft shares have fallen by about 10% since it made the Yahoo offer - wiping almost $35bn from its share value.

Microsoft wants to merge with Yahoo to increase its online presence and enable it to better compete with industry leader Google.