Shutting out Microsoft sets the stage for a high-profile agreement between two titans of the Internet. Under the deal, expected to be announced as early as next week, Google would get a 5 percent stake in AOL, implying a $20 billion value for the unit, said one official with direct knowledge of Time Warner's negotiating position.
Google, which operates the Internet's dominant search tools, also agreed to highlight AOL's Web properties as sponsored links and integrate AOL's video clips in its fledgling Google Video service. In exchange, AOL will continue providing Google's search engine to its subscribers.
Officials described the negotiations on condition of anonymity because no agreement has yet been formalized. The deal could be finalized next week, when Time Warner's board meets in New York.
The deal shows that Google is willing to pay to preserve its lucrative relationship with AOL and prevent Microsoft from becoming a bigger provider of Internet search tools. A deal between Microsoft and AOL would have made Microsoft's own advertising network more attractive.
The struggle over AOL reflects the larger competitive landscape between rivals Google and Microsoft, said Internet analyst Scott Kessler of Standard and Poor's.
The proposed agreement with Google gives AOL more flexibility to sell Google search ads, and have them appear only on AOL sites. The online service currently directs advertisers to Google and cannot limit search ads to its own sites.
AOL is Google's biggest customer, accounting for about $420 million, or about 10 percent, of Google's revenue during the first nine months of this year, according to regulatory filings.
Most of the $420 million came from the ads Google distributes on AOL's Web site. The two companies first began working together in 2002 when Google wrestled away AOL from another online advertising network currently owned by Yahoo Inc.
Microsoft, which increasingly views Google as a fierce rival, has been negotiating with Time Warner since early this year but did not propose any cash investment in AOL, officials said.
Time Warner has been considering options for ramping up AOL's business against a backdrop of criticism from financier Carl Icahn, who is demanding that the company take drastic steps to improve its long-lagging share price, including a massive share buyback.
AOL is shifting its business model from selling dialup Internet access to selling online advertising, which is booming. Google, Microsoft and earlier Yahoo Inc. all expressed interest in some kind of partnership with or stake in AOL to harness its large reach among Internet users.
Microsoft and The Associated Press last month announced plans for an advertising-supported online video news network early in 2006. Microsoft will supply the technology, video player and advertising support to the network, while AP's broadcast division will provide the video, which will feature about 50 different stories per day.