Microsoft, Yahoo! Keep Playing Chicken

Investors are waiting for the software giant's next move to break Yahoo!'s resolve.
By Ivy Lessner ,

SAN FRANCISCO -- Investors and analysts are now waiting for Microsoft (MSFT) - Get Report to drop the other shoe.

The company

had indicated last Thursday that it would disclose early this week

its next move in pursuit of a merger with

Yahoo!

(YHOO)

.

Yahoo! has apparently allowed a Saturday deadline to accept or negotiate Microsoft's $31-a-share offer to pass quietly. Microsoft recently gave plenty of clues that if Yahoo! didn't accept, it would either go it alone, or announce a hostile proxy action to secure its rival for search-advertising market share.

"Microsoft is likely to back off for now," says Roger Kay, a stock analyst with Endpoint Technologies Associates. "I don't think they are going to raise the bid. If they back off and Yahoo!'s stock price tanks, Microsoft is free to come back in and offer a lower price, demonstrating that it was the bid that was keeping the price higher -- not Yahoo!'s assertion that it was because of locked future value."

Cowen analyst James Friedland says Microsoft's deadline was just another part of the negotiating process.

"This is a game of chicken," he says. "To its credit, Yahoo! is hanging in tough, but their alternatives are not very attractive."

Friedland says if the deal collapses, Yahoo!'s price will likely plummet.

Yahoo!'s stock was up 13 cents, or 0.5%, to $26.93 in recent trading. Microsoft shares were down 71 cents, or 2.4%, to $29.12. Yahoo! shares had closed just above $19 the day before Microsoft's offer.

For its part, Yahoo! isn't worried about a fight over control of its board, because the company "has a fair degree of confidence that it has a strong block of votes in the

event of a proxy battle," Kay says. A proxy fight "would be nastier and uglier and down to the minute."

And both companies acknowledge that a hostile merger would reduce the deal's value.

Martin Pyykkonen, an analyst for Global Crown Capital, says that every day that Yahoo! sits on its hands, it runs a greater risk of alienating its shareholders. But by letting Microsoft's deadline pass with no action, the Internet giant may have made a strategic move.

"Yahoo!'s calling their bluff for the time being," he says.

For Microsoft, three weeks probably seemed like enough time to work out a deal while also giving some sense of finality to the ongoing dance between the two companies, Pyykkonen says. Microsoft's deadline may have been based on its expectations that Yahoo! would blow its first-quarter results. Instead, Yahoo! managed to beat estimates and maintain its guidance.

Nonetheless, there is still pressure for Yahoo! to act, whether by negotiating with Microsoft or coming up with an alternative, which thus far it has been unable to do.

Yahoo! has been in talks with

Time Warner's

(TWX)

AOL division, and has outsourced some of its online ads to Google, but none of these options has proven to be a long-term solution.

What Yahoo! has working in its favor is Microsoft's desire to reach an agreement sooner rather than later. And that could help it to squeeze more money out of Microsoft.

"They're banking on

the fact that Microsoft probably doesn't want to conduct a hostile takeover," Friedland says.

Microsoft, on the other hand, wants to acquire Yahoo! at the lowest cost possible and hoped to accomplish that with its three-week deadline.

"Microsoft tried to push Yahoo! harder to accept the original terms and nothing's changed," Friedland says. "So you have to question what Microsoft's next move is going to be."

Microsoft needs Yahoo!'s online traffic and search share to gain traction with advertisers in its competitive battle with

Google

(GOOG) - Get Report

.

One sell-side analyst, who asked not to be named, discounts the possibility that Microsoft can grow its search and advertising shares organically, since it has floundered up to now. After years of trying to drive organic growth, the Redmond, Wash., software giant is pursuing Yahoo! because it's the best means to the end, he says.

Nielsen put Microsoft's search share in March at 12%, Yahoo!'s at 18% and Google's at 59%. Since January, Microsoft's share has held steady, while Yahoo! has lost one percentage point to Google.

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