But as Yahoo's troubles deepened in the second half of that year and throughout 2007, and as Microsoft kept spinning its wheels in its online efforts to compete against Google, the idea of a merger began to seem plausible.
On 1 February, the rumours became a reality as Microsoft announced its $44.6 billion (£22.9 billion) acquisition offer for Yahoo.
Over the next three months, the companies starred in a highly emotional exchange of accusations, veiled insults and threats that culminated in Microsoft withdrawing its offer on 3 May.
That wasn't the end, however. The companies engaged in a fresh round of conflicting accounts as to why the talks collapsed, and Yahoo's CEO Jerry Yang found his actions being publicly second-guessed by vocal shareholders and financial and industry analysts.
Now in the latest twist, the billionaire investor Carl Icahn has reportedly bought 50 million shares of Yahoo stock and is considering a proxy fight to replace its board members and rekindle the talks with Microsoft.
Here is a timeline of the major milestones of Microsoft's pursuit of Yahoo:
May 2006: Some of the earliest rumours that Microsoft is considering an offer to buy Yahoo appear in the New York Post and The Wall Street Journal; at the time such a deal is considered far-fetched and the rumours are dismissed fairly quickly.
October 2006: Rumours begin to swirl that Yahoo has approached Time Warner about purchasing AOL, a notion somewhat more believable than a Microsoft-Yahoo deal.
2007: Microsoft-Yahoo rumours surface from time to time but disappear soon after, as there is nothing to substantiate them.
1 Feb., 2008: In the shot heard 'round the Internet, Microsoft makes a formal purchase offer of $44.6bn (£22.9bn) based on Yahoo's stock price of $19.18; Yahoo's stock price starts rising.
11 Feb.: Yahoo rejects Microsoft's offer as too low; Yahoo's stock price closes at $29.87. According to the rumour mill, Yahoo is now looking for closer to $40 a share because the value of the company has risen since the offer.
12 Feb.: Microsoft for the first time publicly hints in a letter to Yahoo that it is Yahoo rejects Microsoft's offer in its takeover, saying it "reserves the right to pursue all necessary steps to ensure that Yahoo's shareholders are provided with the opportunity to realize the value inherent in our proposal."
5 March: Reports emerge that Yahoo is stepping up negotiations with Time Warner for some kind of tie-up with AOL. Meanwhile, reports make the rounds that Microsoft will mount a proxy fight if Yahoo won't play ball.
11 March: News Corp.'s Rupert Murdoch says he won't "get into a fight" with Microsoft over Yahoo, because the software giant has "a lot more money" than his company.
5 April: Microsoft sends Yahoo a join-us-or-die letter, claiming that if the two companies can't make a deal in three weeks, Microsoft will take its offer directly to shareholders in a proxy battle. In the letter, signed by Microsoft CEO Steve Ballmer, Microsoft basically tells Yahoo board members they've run out of better options, and it would be foolish not to accept an offer immediately. Microsoft also hints that it would consider Yahoo less valuable if it is forced to mount a proxy fight, thus threatening to lower its offer.
7 April: Yahoo again rejects Microsoft's offer on the basis that it is too low. In a letter signed by Chairman Roy Bostock and Yang, the company calls Microsoft's threat of a proxy battle "unproductive" and says it would consider a deal if Microsoft were willing to pony up more money.
9 April: Yahoo says it is testing the display of Google search ads in a small number of its search-engine queries, a move seen as a way to stave off Microsoft's advances. Microsoft immediately attacks the move as anticompetitive and says it would never pass regulatory approval.
10 April: News Corp. is said to be in talks with Microsoft to join forces to buy Yahoo, seen by many as a way that Microsoft can raise its offer without spending more money. At the same time, talk of a Yahoo-AOL union again again makes the rounds.
22 April: In the most closely watched earnings reports of its history, Yahoo delivers solid, although not stellar, first-quarter financial results, growing its revenue and net income and exceeding Wall Street's expectations for both. Yang describes the quarter, ended 31 March, as one of Yahoo's "most exciting" ever. He adds that Yahoo's management and directors are open to any alternatives to maximize shareholder value, including a sale to Microsoft, but they remain convinced that the current bid significantly undervalues the company.
26 April: The deadline set by Microsoft for wrapping up negotiations on a deal passes without an agreement being reached. The wait begins for Microsoft to announce its next move. Days earlier, Ballmer and Microsoft Chief Financial Officer Chris Liddell raise the possibility for the first time that Microsoft, instead of attempting a hostile takeover, might walk away from the deal instead.
30 April: The Wall Street Journal reports that Microsoft's board met to decide how to proceed with the company's bid to acquire Yahoo, and that no final decision was reached. The Journal, by now viewed as the companies' preferred conduit for anonymous leaks, reports that the major stumbling block has been price, which Microsoft is willing to increase to $33 per share, but not to the $35 to $37 range that major Yahoo shareholders, management and board members want.
2 May: Microsoft and Yahoo have turned a corner and are finally negotiating in earnest about a possible merger, although a deal is far from imminent, The New York Times and The Wall Street Journal report, citing anonymous sources.
3 May: Microsoft surprises many by announcing that it will drop its acquisition attempt. It confirms that it offered to raise its initial bid to $33 per share, an increase of about $5 billion, but that Yahoo was holding out for $37 per share. "After careful consideration, we believe the economics demanded by Yahoo do not make sense for us, and it is in the best interests of Microsoft stockholders, employees and other stakeholders to withdraw our proposal," Ballmer said in a statement.
In response, Yahoo reiterates its position that Microsoft's offer was too low, and says that many Yahoo shareholders agreed with it. Yang says in a statement that "with the distraction of Microsoft's unsolicited proposal now behind us," Yahoo can continue with "the most important transition in our history."
5 May: Yahoo's stock loses significant value on the first day of trading after Microsoft decided over the weekend to walk away from the acquisition. Yahoo's shares close down 15 percent at $24.37, after dropping as low as $22.97 during the day. Large shareholders criticize Yang and the board for letting the deal slip away.
In response, Yang grants a series of interviews to large newspapers, saying he is still open to selling Yahoo to Microsoft or another suitor if the price is right. He tells the Financial Times that it was Microsoft, not Yahoo, that was unwilling to complete the deal; his company wanted to continue negotiations on a price. "We did not say it was a take-it-or-leave-it number in the sense that we would never negotiate any more," he said. "We were totally willing to do a transaction, and they walked away."
Also on this day, Yahoo finally sets a date for its shareholders meeting -- July 3rd. According to its amended bylaws, shareholders have until May 15 to nominate candidates to the board, whose 10 incumbent directors are up for re-election this year.
6 May: In an interview with Yahoo's "TechTicker," Yahoo President Sue Decker says Microsoft never put its revised $33 per share offer in writing, and acknowledges that a combination of Yahoo and Microsoft assets could yield a very successful company.
7 May: Echoing - and adding significant weight to - comments made by other Microsoft officials, Chairman Bill Gates says in Tokyo that Microsoft won't be pursuing tie-ups or takeovers to replace its failed Yahoo bid. Referencing comments made by Ballmer, Gates said that "now at this point, Microsoft is focused on its independent strategy."
13 May: Billionaire investor Carl Icahn is mulling a proxy fight against Yahoo's current board members in order to pressure the company to re-establish merger negotiations with Microsoft, CNBC and The Wall Street Journal report.
Icahn has bought as many as 50 million Yahoo shares since Microsoft walked away from the deal, they report, citing anonymous sources. Microsoft hasn't indicated to Icahn that it would return to the negotiating table, however, and Icahn hasn't decided whether he will go through with the proxy fight.