SEATTLE (Reuters) - Microsoft Corp said on Sunday it has proposed an alternative deal to Yahoo Inc, rather than a full acquisition, in a move that could save the web pioneer from fighting a proxy battle with financier Carl Icahn.

"Microsoft is considering and has raised with Yahoo an alternative that would involve a transaction with Yahoo but not an acquisition of all of Yahoo," the company said in a statement without clarifying what that alternative might be.

Microsoft emphasized it was not proposing to make a new bid to buy all of Yahoo "but reserves the right to reconsider that alternative" depending on discussions with Yahoo, shareholders of Yahoo or Microsoft, or other third parties.

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A source familiar with Microsoft's thinking said Yahoo was responsive to Microsoft's latest proposal but emphasized that discussions between the two companies may not result in a deal.

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, which dominates the search market with a share significantly larger than a combined Yahoo and Microsoft.

For its part, Yahoo continues to talk with Google Inc about a search advertising partnership and a deal could come as early as this week, a source familiar with the talks said on Thursday.

The statement from Microsoft comes on the heels of a proxy campaign launched on Thursday by Icahn 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.

Meanwhile, Microsoft and Icahn have not held discussions about Yahoo, said another source close to the company. A spokesman for Yahoo declined to comment and Icahn could not be reached for comment.

Kim Caughey, a senior analyst at Fort Pitt Capital Group, said the market will probably send Yahoo shares higher while pushing down Microsoft shares when the market opens on Monday.

Caughey said a joint venture or minority investment with Yahoo could cause confusion about who was in charge.

"Microsoft walking away from Yahoo was a total head fake," said Caughey. "Microsoft is a terrible poker player if it thought people were going to believe that the deal was dead."

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