Google has agreed to pay US$1 billion ($1.45 billion) for 5 per cent of Time Warner's America Online unit, shutting out rival bidder Microsoft, said a source familiar with the discussions.

An agreement between AOL and Google is a blow to Microsoft, the world's largest software maker, which initiated discussions with AOL in January, eight months before Google.

Google, the most-used search engine, will retain AOL as its largest client and be able to wage a better challenge to Yahoo!'s news and entertainment websites.

"It's a pre-emptive move against Microsoft," said Martin Pyykkonen, an analyst with Hoefer & Arnett in Denver.

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