Updated from 3:33 p.m. EST

SAN FRANCISCO - Yahoo!'s ( YHOO) rejection of Microsoft's ( MSFT) offer could just be a lesson in Negotiation 101, but look for the Internet search veteran to take more evasive actions.

The rejection letter from Yahoo! on Monday is a typical first step in a well-tread mating ritual, much like BEA Systems' ( BEAS) rejection of Oracle's ( ORCL) public takeover offer in October, which was later accepted at a higher price.

Yahoo's board has set the stage for further negotiations by suggesting a price of $40 a share, according to the Wall Street Journal, capping an ultimate settlement in a range starting at Microsoft's $31-a-share bid. The value of that half-cash/half-stock offer has already fallen due to the drop in Microsoft's share price since the bid was announced Feb. 1.

Later Monday, Microsoft responded to Yahoo!'s rejection in a press release, calling it "unfortunate," and saying that "we are confident that moving forward promptly to consummate a transaction is in the best interests of all parties."

The company also held up the not-so-veiled threat of a hostile bid: "Microsoft reserves the right to pursue all necessary steps to ensure that Yahoo!'s shareholders are provided with the opportunity to realize the value inherent in our proposal."

Yet reports that Yahoo! is looking for any out that doesn't involve Microsoft, if true, indicates the company is desperate, akin to Jaws' Quint grasping for any straw that could keep him from the maw of the shark.

Over the weekend, the Times of London reported that Yahoo! investigating a tie-up with Time Warner's ( TWX) AOL unit as a counter to Microsoft's bid.

Continued resistance from Yahoo! may force the Redmond, Wash., company into more hostile measures. For example, Microsoft could take its offer directly to shareholders. In doing so, it may start the clock on the anticipated antitrust review. Speeding that process would be in Microsoft's best interests. The company has said it hopes to conclude the acquisition by late 2008.

RBC analyst Robert Breza expects the two companies to come to terms within the next month, followed by an antitrust regulatory process that could take from 8 to 12 months, he wrote Monday. RBC Capital makes a market in Microsoft. Yahoo! is an investment banking client of the firm.

"We believe a deal will likely get done between $35 to $40 per share and possibly carry a higher cash/debt component" than the 50-50 split Microsoft previously outlined, Breza wrote.

The deal strategically makes sense for Microsoft, Breza noted.

Late last week, Citigroup analyst Brent Thill also viewed the scenario of a sweetened bid as the most likely outcome, followed by a deal in which Yahoo! outsources search advertising to Microsoft arch-competitor Google ( GOOG). Microsoft and Yahoo! are investment banking clients of Citigroup.

With a market share in text-based search of more than 50% and growing, Google enjoys a "natural monopoly" that Microsoft is unlikely to break, said Kevin Kemmerer, senior vice president at venture investor Safeguard Scientifics ( SFE). The merger "will only lead to a reduction in market share for a combined Microsoft."

The merger has big implications for Safeguard Scientifics, which has equity stakes in smaller Internet properties such as Bridgevine and Beyond.com. The success of these sites is tied directly to the ability of these search engines to convert queries into hits.

Kemmerer views both Microsoft and Yahoo! as potential bidders for the VC firm's startup Internet properties. "I need as many bidders as possible. Take one out, and I lose a potential acquirer," he said.

While that's an argument for regulators to take a hard look at Microsoft's designs on Yahoo!, Kemmerer says it is a bad deal for both companies and, inevitably, Microsoft shareholders.

"The only way to overcome Google is to innovate," Kemmerer said. Any of the three companies that either improves its search engine or tunes its ad-serving algorithms derives a distinct advantage. If a combined Microsoft and Yahoo! can't come up with innovation in one of those areas, Google will continue to take search and ad-serving market share.

Kemmerer doesn't see Microsoft pulling that off while focused on the integration, which would take a full year with its attendant culture-clash issues, and competition with Google.

"The reality is they're fighting the battle on the wrong battlefield," Kemmerer said. He questions Microsoft's replay of a skirmish - search market share -- that it has already lost. Instead, Microsoft should have its eye on "the next big battlegrounds" -- mobile and video. Microsoft would do well to put its massive resources toward capturing the market for cell phone software and content-delivery mechanisms, such as serving video and ads to mobile phones and PCs.

With Internet TV, cable networks will lose their stranglehold on video delivery, Kemmerer said. "Somebody else is going to have the opportunity to package content."

Microsoft is well-positioned to monetize the opportunity with its Xbox game platform, Media Center and MSN site. "That's the battle I'd want" Microsoft to wage, Kemmerer said.

For the company, that's not an either-or proposition. To its credit, Microsoft is trying to take advantage of those market opportunities. The company is well along in its efforts to integrate its Windows Mobile software with these platforms and expects to do more to serve and share content and ads among its properties and partners, such as Facebook, in which it has an equity stake.

On Friday blog sites Valleywag and TechCrunch reported that Microsoft is going after Ustream.tv, a live streaming video site, for more than $50 million.

According to Valleywag, Microsoft would use the popular destination to promote its Silverlight technology, a browser plug-in for video and animation that competes with Adobe's ( ADBE) Flash player.

On Monday, Microsoft said it will acquire mobile Web services provider Danger, which supplies software and on-demand Internet access to Sharp and Motorola ( MSFT) handsets through operators such as T-Mobile. Danger's revenue grew 14% in fiscal 2007, to $56.4 million. Its hosted service provides Internet browsing, email, messaging and premium content to cell phones. Danger, of Palo Alto, Calif., had filed in December its intent to go public. Terms of the buyout were not disclosed.

Microsoft isn't the only giant with vulnerabilities in the ever-changing search game. Google, whose standing as the search and online advertising leader is usually viewed as impenetrable, "is a one-trick pony," according to Nick Patience, managing analyst at the 451 Group.

Google's "revenues are always 99% advertising," with other services adding the remaining 1%, Patience said. "They should be worried about somebody going after their core business," he added, regarding Google's public and private efforts to derail a Microsoft-Yahoo! merger.

Like many analysts, Patience does not see antitrust issues preventing the merger. He compared it to Oracle ( ORCL), No. 2 in the middleware market after IBM ( IBM), buying No. 3 BEA Systems ( BEAS), a deal that has not yet cleared regulatory scrutiny.

He also cited Oracle's earlier buyout of PeopleSoft to go up against SAP ( SAP), which was No. 1 in human resources software.

Microsoft's argument will be that Google, in terms of search-based advertising, is much farther ahead, Patience said.

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