Yahoo's rejection of Microsoft's unsolicited takeover bid left investors guessing the next move in a tense mating dance that may hatch a more imposing challenger to Google or disintegrate into a bruising brawl.
The rebuff, formally announced early Monday, wasn't a surprise because Yahoo had leaked its intention over the weekend.
As expected, Yahoo's board unanimously decided to spurn Microsoft after concluding the offer — originally worth $44.6 billion or $31 per share — "substantially undervalues" one of the Internet's prized franchises. The cash-and stock deal is now valued at about $40 billion, or $28.91 per share, because of a drop in Microsoft's market value.
But Yahoo didn't raise antitrust concerns about the proposed deal and included language that seemed to invite a higher offer from Microsoft, the world's largest software maker.
"The board of directors is continually evaluating all of its strategic options in the context of the rapidly evolving industry environment and we remain committed to pursuing initiatives that maximize value for all stockholders," Yahoo said in a statement.
Microsoft, though, didn't seem inclined to raise the bid Monday, releasing a statement describing its current bid as "full and fair."
Calling Yahoo's decision "unfortunate," Microsoft didn't back off from its quest either. "Based on conversations with stakeholders of both companies, we are confident that moving forward promptly to consummate a transaction is in the best interests of all parties," the Redmond,wash-based company said.
Microsoft also emphasized it's prepared to "pursue all necessary steps" to get the deal done, raising the prospect that it could take the bid directly to Yahoo shareholders with a so-called "exchange offer" or escalate the acrimony even further by trying to oust Yahoo's 10-member board later this year.
While assessing its response to Microsoft, Yahoo's board also examined a wide range of alternatives that included forging an ad partnership with Google, which paid nearly $5 billion in marketing commissions to thousands of Web sites last year.
Without identifying its sources, the Times of London also reported Yahoo is exploring a merger with Time warner's AOL, another popular Internet property that has been struggling in recent years. A Yahoo spokesman declined to comment on the report.
Investors appear convinced Microsoft's bid remains Yahoo's best bet, given the Sunnyvale-based company's profits have been steadily declining despite a management shake up eight months ago and repeated promises of a turnaround extending back to 2006.
Reflecting Wall Street's belief that Microsoft will raise its bid, Yahoo shares climbed 67 cents Monday to close at $29.87. On the flip side, Microsoft's shares dropped 35 cents to finish at $28.21 as its shareholders continued to fret that a Yahoo acquisition could turn into more trouble than its worth.
Microsoft's advisers are believed to be working behind the scenes to rally support among Yahoo shareholders and determine how much more the bid needs to be increased to force Yahoo's board to negotiate a friendly deal.
"You would assume that their first offer isn't the best and final offer," said Morton Pierce, an attorney who advises on mergers and acquisitions for the law firm Dewey & LeBouef. "The question now is how do you get to the end game?"
To further complicate matters, some of Yahoo's major shareholders might not want Microsoft to bid much more because they also own large stakes in Microsoft. The overlapping holdings mean any gain that these big shareholders might realize from a sweetened Microsoft offer might be erased if a higher bid diminishes Microsoft's market value, which has already slid about $40 billion, or 13 percent, since the takeover saga began.
Capital Research and Management Company., Barclays Global investors, Vanguard Group Inc. and State Street Global Advisers rank among the five largest shareholders for both Yahoo and Microsoft, according to Factset Research System Inc.
Most analysts still seem to think Microsoft will raise its bid because it needs to buy Yahoo quickly to close Google's widening lead in the lucrative online search and advertising markets that are rapidly reshaping the technology and media industries.
Meanwhile, Yahoo finds itself in a bind because its stock was near a four-year low before the Microsoft bid surfaced and its management already has said things are unlikely to get significantly better until 2009.
"Both companies seem to have limited options to achieve their goals, so it appears they really do need each other," said Standford Group Campany. analyst Clayton Moran.
Although its profits have been dwindling during the past two years, Yahoo still possesses one of the Internet's biggest audiences and largest ad networks.
Still, those assets haven't been compelling enough to persuade other potential suits to counter Microsoft's bid, despite Yahoo's best efforts to drum up interest in the past week.
That could lessen the incentive for Microsoft to raise its bid. But Yahoo wouldn't have had any chance of extracting more money unless its board spurned the initial offer.
"This was a logical move by Yahoo's board, but I still think this deal is going to get done," said Ryan Jacob, a money manager who owns Yahoo shares in an Internet investment fund bearing his name. "I think most shareholders will be ready to accept if the bid is raised to the mid-$30 (per share)."
Yahoo's stock price had dropped by more than 40 percent in the three months leading up to Microsoft's bid, which was announced Feb. 1. The offer was 62 percent above Yahoo's market value at the time.
Microsoft was prepared to pay at least $40 per share for Yahoo a year ago, according to a person familiar with the earlier talks between the two companies. Yahoo wasn't interested then because it was confident in its own strategy, said the person, who didn't want to be identified because Microsoft's 2007 offer was never publicly disclosed.
If Microsoft doesn't want to pay more money, it will probably have to assume a more hostile stance that risks creating hard feelings at Yahoo and making it more difficult to cobble the two businesses together if a deal is consummated.
Analysts doubt either side wants to become locked into a divisive struggle that could distract both management teams for months while Google tried to capitalize on the impasse.
If Yahoo isn't sold, Chief Executive Jerry Yang assured employees in a Monday e-mail that the company is poised to rebound on its own and become a "must buy" in the $45 billion online advertising market.
"We have accomplished a great deal in a very short time," wrote Yang, a company co-founder and board member who promised better times after he became CEO eight months ago. "Yahoo is a faster-moving, better organized, more nimble company well on its way to transforming the experiences of its users, advertisers, publishers and developers."
Just two days before Microsoft made its bid, Yang warned Yahoo faced "headwinds" in 2008 and laid out plans to eliminate 1,000 jobs, or about 7 percent of the company's work force, to boost profits.
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