Upgrade Sends Yahoo! Shares Higher

Updated from 1:31 p.m. EDT

SAN FRANCISCO -- Shares of Yahoo!(YHOO Quote) climbed Tuesday after a Citigroup analyst upgraded the stock and speculated that Microsoft(MSFT Quote) could raise its bid for the company to $34 a share.

Analyst Mark Mahaney, who has maintained all along that a Microsoft-Yahoo! merger is likely to happen, wrote that he sees little reason for the software giant to walk away, even though Yahoo! has already turned down the offer.

"While regulatory risk may be material, we continue to believe that limited combined market share allows the deal to go through," Mahaney wrote in his most recent research. Citigroup makes a market in Yahoo! shares.

Shares of Yahoo! were up 3.3%, or 92 cents, to $28.44 in afternoon trading.

Mahaney pointed out that after three or four years of Microsoft making online advertising its key priority, it has been unable to gain any traction. Meanwhile, Google(GOOG Quote) has seen a significant increase in its share of online advertising, and could potentially strengthen its lead with its recent acquisition of online ad-services firm DoubleClick.

Microsoft's initial offer for Yahoo! was valued at $31 a share. Mahaney said he would consider a $34 a share offer to be "a reasonable, valuation-supported base case for Yahoo!."

"We believe buying YHOO shares here provides an attractive return," he wrote in his research.

Mahaney said he believes Yahoo! is continuing to aggressively pursue alternatives to Microsoft, including a possible deal with Time Warner(TWX Quote), whereby Time Warner would contribute its online assets -- namely AOL -- to Yahoo! in exchange for a stake in the company.

So far, Time Warner has not commented on such a deal and some analysts wonder if the company is even interested in Yahoo!, especially after Time Warner's recent acquisition of social-networking outfit, Bebo, for $850 million in cash.

Nonetheless, Mahaney said he believed Yahoo!'s pursuit of other alternatives might ultimately work in its favor.

"We believe this could serve as a forcing function to a higher MSFT bid," he said.

Know What You Own: Yahoo! operates in the internet industry, and some of the other stocks in its field include Google(GOOG Quote). This stock was recently trading at ($452.40, -1.77%). For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.