Is Microsoft Ready to Walk Away?

A decision is likely to emerge in the next few days. Although Yahoo's weekend deadline to accept the offer expired Saturday, Microsoft has indicated it probably won't reveal its next move until early this week.

The tense mating dance is at a standstill because Yahoo's board has repeatedly said it won't sell to Microsoft for less than $45 billion, even though the bid hoisted its stock shortly after it hit a four-year low in late January.

A Negotiating Ploy?

The impasse has left most analysts predicting Microsoft will either sweeten its offer or attempt to replace Yahoo's board with a slate of directors who will embrace a takeover.

However, the architects of Microsoft's bid -- chief executive Steve Ballmer and Chief Financial Officer Chris Liddell -- have been signaling the Redmond, Wash.-based company might abandon the bid and leave Sunnyvale, Calif.-based Yahoo twisting in the wind.

The public remarks of Ballmer and Liddell could be just part of a negotiating ploy aimed at pressuring Yahoo to the negotiating table.

However, some analysts think Microsoft would be smart to walk away now.

By turning a cold shoulder, Microsoft could position itself to return with another bid this summer in hopes of completing the acquisition without suffering through the disruption and rancor likely to erupt if Microsoft were to try to oust Yahoo's board in a risky process known as a proxy contest.

This scenario could only pan out if Microsoft is correct in its belief that Yahoo is stuck in a downward spiral after steadily losing ground in the online advertising market during the past two years.

Value of Yahoo Shares

Unless Yahoo can bounce back, its shares might eventually drop even lower than their $19.18 price when Microsoft made its initial bid of $31.

Yahoo shares fell 50 cents to finish Friday at $26.80, pulled down by the declining value of Microsoft's cash-and-stock bid.

Driven by Wall Street's disappointment with the company's short-term outlook, Microsoft shares dropped $1.97 to $29.83 on Friday. The decline lowered the value of the Yahoo bid to $42.7 billion, or $29.68 per share.

If Yahoo's stock were to plummet into the mid-teens, Microsoft conceivably could return with another offer that would probably be more warmly received than its original bid.

"Yahoo management would be under inordinate pressure to accept at that point," said Dinosaur Securities analyst David Garrity. "Why go through all the distractions and expense of a proxy fight if you see another way" to an amicable transaction?

Yahoo management has expressed confidence in a turnaround plan that projects revenue increases of 25 percent in 2009 and 2010. However, analyst estimates for those years have remained substantially below those targets -- a sign of the widespread skepticism about whether Yahoo will be able to reach its ambitious goals.

Completing the Transaction

Abandoned takeover bids have paved the way to corporate acquisitions before. Just last fall, Oracle (Nasdaq: ORCL) withdrew a $6.7 billion bid for rival business software maker BEA Systems (Nasdaq: BEAS) after being spurned and then wrapped up the takeover for $8.5 billion three months later.

Other analysts remain convinced Microsoft will either raise its bid or launch a proxy contest because it needs Yahoo's franchise to mount a more serious challenge against Google's (Nasdaq: GOOG) dominance of the Internet's search and advertising market.

"We still believe [Microsoft] is committed to completing the transaction and is unlikely to walk away," Citigroup analyst Brent Thill wrote in a Friday note.

McAdams Wright Ragen analyst Sid Parakh said he can't envision Microsoft raising its offer, especially since Yahoo's management hasn't proven its strategy will boost the company's stock price above $30 on its own.

Microsoft's current bid is "already a stretch, and I don't see any reason for them to really bid against themselves," Parakh said.

Other Options

Yahoo could try to extract a higher bid by farming out some of the advertising on its Web site to Google. The two sides just completed a two-week trial that allowed Google to show text-based advertising along a small percentage of Yahoo's search results.

A long-term advertising partnership with Google probably would provide a significant boost to Yahoo's profits, but antitrust concerns might block an alliance between the owners of the Internet's two largest search engines. Combined, Google and Yahoo control more than 80 percent of the U.S. search market.

Yahoo also has been exploring a possible merger with the online operations of Time Warner's (NYSE: TWX) AOL, but most analysts view that as a weaker alternative to a Microsoft takeover.

As it stands now, Yahoo's first-quarter revenue growth of 9 percent is far behind both Google's and Microsoft's online services division, which climbed 42 percent and 40 percent, respectively.

That's just one reason Garrity believes Ballmer and Liddell are realizing that Microsoft doesn't need Yahoo at any price.

"Sometimes the best deals are the ones that aren't done," he said.