Microsoft founder and chairman Bill Gates warned Yahoo management yesterday that if it fails in its bid for the internet company, Microsoft will heavily invest in internet technologies in order to compete against Google.

Mr Gates said Microsoft's $44.6 billion unsolicited bid for Yahoo was "very fair" but gave the clearest indication yet that the world's largest software company would be willing to walk away from the deal.

"We can afford to make big investments in the engineering and marketing that needs to get done. We will do that with or without Yahoo," said Mr Gates.

"But we also see that we'd get there faster if the great engineering work that Yahoo has done and the great engineers there were part of the common effort," said Mr Gates, who is Microsoft's biggest shareholder.

Although Mr Gates said Microsoft had not done anything since sending its offer letter to the Yahoo board on January 31st, the New York Times yesterday reported that Microsoft would start a proxy fight if Yahoo did not begin negotiations. Last week the Yahoo board rejected the Microsoft bid as undervaluing the company.

It is understood Microsoft will seek to nominate its own directors to Yahoo's board in advance of the March 13th deadline for nominations.

All of Yahoo's directors are due for re-election at its next annual meeting. Microsoft would then canvass Yahoo shareholders to support its nominees. Such a move would most likely lead to a protracted struggle for control of the Yahoo board.

The New York Times says that such a move would cost $20-$30 million but this would be a relatively cheap way to put pressure on the Yahoo board compared to raising its offer of $31 a share.

The fall in Microsoft's share price since the offer was announced means the value of the deal, which would see Yahoo shareholders get half their payment in Microsoft stock, has reduced to about $41 billion.- (Additional reporting: Reuters)