Dow Jones newswire service Market Talk reported this morning that market conditions are ripe for AOL and Yahoo to merge with each other or be acquired by another company, perhaps Microsoft, according to a new Merrill Lynch analyst report by Jessica Reif Cohen and Justin Post released today.

iMedia has obtained a copy of the report, which argues that either AOL or Yahoo or both companies are ripe for "a transformative transaction in the coming 12 to 24 months."

"Although not without its problems, we believe that an AOL-Yahoo combination is one of the more logical combinations in this arena (either company could also end up as part of Microsoft)," the report states.

A number of factors feed into Reif Cohen and Post's analysis, including the projected growth of online advertising to 10 percent of the overall marketing spend by 2010, AOL's move to an ad-supported format and Yahoo's and Microsoft's continued loss of ground in search to Google. However, the report suggests that, "the hiring of Randy Falco as the head of AOL could mean a transaction is somewhat less likely" on the AOL side.

Such a merger would enable the transformed Yahoo to outsource its paid search to Google, resulting in significant cost savings; the same would be true if either News Corp of Comcast purchased Yahoo, although the analysts regard this to be a less likely scenario.

AOL's ownership of Advertising.com is another factor making a merger of AOL and Yahoo attractive, since Yahoo has "remained relatively challenged" in the sale of remnant advertising, which is "a source of strength" for the AOL subsidiary. However, Yahoo's recent 20 percent acquisition of Right Media's online ad exchange should change the company's capabilities in that regard.

Rumors about Yahoo acquiring AOL last surfaced in October in an article by FORTUNE magazine.