Microsoft has failed in its initial bid to acquire Yahoo, after Yahoo failed to agree to the deal by Microsoft's Saturday deadline.
Now Microsoft must decide whether to pursue a hostile takeover via a proxy fight or to drop the bid and seek other acquisition alternatives.
All along, Microsoft's management had indicated strongly that they would pursue Yahoo via all available options, including the hostile route of ousting the current board by proposing its own slate of director candidates at the next Yahoo shareholders' meeting.
But Microsoft CEO Steve Ballmer and CFO Chris Liddell softened that stance in public comments last week, saying that giving up on the acquisition would also be an option.
On Sunday, Yahoo declined to comment. Microsoft responded by pointing to comments Liddell made on Thursday during Microsoft's earnings announcement.
"Unless we make progress with Yahoo towards an agreement by this weekend, we will reconsider our alternatives. We will provide updates as appropriate next week, these alternatives clearly including taking an offer to the Yahoo shareholders, or to withdraw our proposal and focus on other opportunities, both organic and inorganic," Liddell said then.
Citing anonymous sources, The Wall Street Journal reported on Sunday that Microsoft, Yahoo and their advisers have held talks in recent weeks but didn't achieve enough progress to hammer out a deal by Saturday.
The process has clearly been frustrating for Microsoft's management, who have maintained that their offer is fair and that they don't see a reason to revise it. Ballmer and his team have shown signs of getting impatient with the slow progress, not surprising considering Microsoft's urgency at boosting its underperforming internet business and competing better against Google.
Launching a proxy fight would prolong even further the acquisition process and make the fight even nastier. Even if Microsoft were to win, it would not be a good start to what would be an arduous and lengthy post-acquisition integration process.
In the meantime, Google would no doubt seek to capitalise on the internal turmoil within Microsoft and Yahoo by trying to poach clients and valuable employees.
As soon as Microsoft announced its bid for Yahoo on February 1 - valued at $44.6bn at the time - Yahoo's management began seeking and considering alternatives, while its stock began to rise from the latest pre-bid price of $19.18.
By the time Yahoo's board formally rejected the unsolicited offer on February 11, saying it undervalued the company, Yahoo's stock price had risen to $29.87, erasing the offer's premium. The next day, Microsoft hinted in a letter to Yahoo that it wouldn't shy away from attempting a hostile takeover.
Since the bid's announcement, Yahoo CEO and co-founder Jerry Yang has held conversations with various companies including Google, AOL, Disney and News Corp, exploring alternative deals that would strengthen Yahoo's business and relieve the pressure on it to be acquired.
On April 5, Microsoft, clearly impatient, threatened Yahoo's board of directors with a proxy battle if it wouldn't agree to a buy-out in the next three weeks. That's the deadline that lapsed on Saturday.
"The focus will be on Microsoft tomorrow [Monday] to make some statement about its intentions," said industry analyst Greg Sterling from Sterling Market Intelligence.
While there is still a reasonable chance that Microsoft will launch a proxy fight, it also seems much more likely than it did three weeks ago that Microsoft will drop its bid, Sterling said. Microsoft's management was clearly expecting a much smoother acquisition process, he said.
"Microsoft's tone during the initial call [announcing the bid] was that this was pretty much 'fait accompli' and that they were already looking past the deal towards the integration process," Sterling said. "Microsoft has been surprised to a degree and really frustrated by the resistance."
No alternative deal has materialised for Yahoo, except for a very limited, albeit eyebrow-raising, test that saw Yahoo run Google ads along with some search engine results on Yahoo.com. Observers speculated that the test, announced on April 9, could lead to a full-blown outsourcing of Yahoo's search ad business to Google, a move that financial analysts believe could boost Yahoo's revenue.
Yahoo also has made overt manoeuvres to buy itself time. For example, on March 5, Yahoo lifted the following week's deadline for nominating directors to its board, an attempt to discourage Microsoft from launching a proxy fight to replace the current board with members willing to approve its Yahoo acquisition bid. Yahoo hasn't yet set a date for its shareholders' meeting.
On March 18, Yahoo kicked off a tour to investors by dusting off a three-month-old financial plan to reinforce its contention that Yahoo is worth much more than Microsoft offered to pay for it. The plan, originally presented to Yahoo's board in December, predicts that Yahoo would double its operating cash flow over the next three years from $1.9bn to $3.7bn. The plan also forecasts that, subtracting the commission that Yahoo pays to sites in its advertising network, Yahoo will generate $8.8bn in revenue in 2010. Financial analysts agreed the plan is highly optimistic.
Yahoo also has been in hyperactive mode with product and strategy announcements since Microsoft's bid, always pointing out that each initiative proved that it is able to improve its situation as an independent company. For example, it acquired online video player Maven Networks, announced its social network OneConnect mobile service, re-launched its video site and introduced Yahoo Buzz, a social news site that has been well received.
It also announced AMP, a new advertising management platform that it says will greatly simplify buying and selling ads online, and that will roll out in phases starting in 2008's third quarter and continuing into 2009. Yahoo also added video to Flickr and joined Google's OpenSocial project of common APIs for social networking applications.
Last week, it announced its most ambitious plan yet to take advantage of the popularity of social networking. Yahoo Open Strategy calls for the company to swing wide open the doors of its web platforms to let outside developers create applications across its network of sites, starting with its search engine via a beta project called Search Monkey.
Also last week, Yahoo reported 2008 first quarter earnings that were considered solid, although not stellar, and that Yang said prove the company is in the rebound. Yahoo grew its revenue and net income and exceeded Wall Street's expectations for both categories.
Of course, there have been also reminders of why Yahoo found itself an acquisition target. The most concrete was on February 12 when Yahoo, as it had been planning to do, started laying off about 1,000 staffers, and prominent executives like Bradley Horowitz, vice president of product strategy, voluntarily gave up on the company and left, in Horowitz's case to arch-rival Google.