Yahoo! May Need Microsoft After All

For Yahoo! investors, the trick is to figure out when the risk of relying heavily on a Microsoft deal is worth it.
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SAN FRANCISCO -- A stock market that has rallied about 20% from multiyear lows set three weeks ago has gone a long way to lift Yahoo! (YHOO) shares, which are up nearly 25% in the same time frame.

But you still can't beat a mention of

Microsoft

(MSFT) - Get Report

for short-term gain.

Monday was no exception: With the

Dow Jones Industrial Average

making a serious run at its first close above 9000 in more than a month, Yahoo! was up nearly 4% to $12.10 on the latest tire-kicking from Microsoft CEO Steve Ballmer.

Specifically,

The Wall Street Journal

reported over the weekend that Ballmer said a deal by Microsoft to acquire Yahoo!'s search business -- the conventional wisdom's most likely route in the aftermath of a failed takeover -- should be struck "sooner rather than later."

Ballmer uttered the comment during a joint interview with Qi Lu, Microsoft's new president of online services, who, as fate would have it, is a former Yahoo! employee. Lu has a huge task to organize Microsoft's Internet strategy, and it's not made any easier with the accepted reality that the first and best thing Microsoft should do is buy Yahoo!'s search operations.

For Yahoo! investors, or those thinking about picking up shares, it's yet another tease that offers the hope of a near-term surge in revenue wrapped in the notion of "Haven't we heard this before?"

Traders are way past the "fool me twice" scenario with Yahoo!. The stock has been the poster child of 2008 disappointment (well, let's exclude the financials, shall we?), falling by two-thirds from the $30 level set earlier this year upon Microsoft's $31-a-share takeout offer.

Each passing month has given investors fleeting reasons for more hope, whether it was renewed buyout talks with Microsoft, a search deal with

Google

(GOOG) - Get Report

, or the departure of CEO Jerry Yang, who was widely seen as the chief roadblock during the Yahoo!-Microsoft buyout talks.

What investors have been left with is a decimated stock and a lesson in attempting to value a company over the short term by using the headlines generated by public negotiating tactics.

Yahoo!'s problems have obviously not evaporated with a rebound in its stock price. Despite a necessary (in that corporate sort of way) 1,500-2,000 job purge in the works, the company is still short a CEO to get the company back on track.

Yahoo! also is in a particularly tough spot because of its inherent strengths and weaknesses amid the ongoing global recession. The company's strength in online display advertising is seen by analysts as exactly where advertisers are pulling back. Search advertising, however, is soft but is holding up relatively better, which isn't as helpful for Yahoo!'s diminished status in that sector.

However, at some point a combination of the economic dourness and Yahoo!'s depressed stock price forces investors to take the Microsoft talk more seriously.

With each day bringing another confirmation or two that near-term tech profits will be under pressure (look for

Texas Instruments

(TXN) - Get Report

to be the next disappointment after the closing bell Monday) for some time, the prospect of Yahoo! boosting its revenue -- when few other tech companies can -- by the stroke of a pen becomes much more appealing. Investment bank Collins Stewart noted last month that a deal could boost Yahoo! shares by $8 to $10.

For investors, the trick is to figure out when the risk of relying heavily on a Microsoft deal is worth it. When the stock was trading closer to $9

just three weeks ago

, Needham analyst Mark May saw good valuation, regardless of Microsoft's interest, noting that the stock's enterprise value (market cap stripped of cash and debt) was trading at just twice its expected 2009 operating earnings -- an all-time low.

Even with a $3 run higher, Yahoo!'s shares are still relatively cheap. But betting on further upside from here, without the need for yet another Microsoft rumor, is not for the faint of heart.