With Microsoft walking away from the Yahoo deal, there’s been a lot of talk about what it’s next best option would be. Going after AOL is an obvious choice. It has the ad inventory (aka pageviews) Microsoft needs, has its own collection of growing online advertising businesses, and has a very willing seller in parent Time Warner. The Times of London is reporting that Microsoft and AOL are in “preliminary talks” about an acquisition. And AOL isn’t exactly hitting on all cylinders right now, so it could be a much cheaper, cleaner purchase.

http://business.timesonline.co.uk/tol/business/industry_sectors/technology/article3876643.ece

Of course, Microsoft is still talking to everybody at this point, except maybe Yahoo. Whether it truly intends to set its sights on AOL is unclear because it needs to talk to AOL at the very least as a strategic ploy to try to thwart any possible deal between Yahoo and AOL (which has always been a possibility in the background). But at least Wall Street doesn’t seem to think that a deal is imminent. Yahoo’s shares are up 4 percent from yesterday to $25 a share right now, while Time Warner’s shares are pretty much flat at $16 after rising about 6 percent last week. Maybe Yahoo’s talks with Google are going better than Microsoft’s talks with AOL.

(Disclosure: As a former employee of Time Warner, I own some shares in the company)

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Tomorrow Yahoo will launch a partnership with McAfee and will integrate their Site Advisor malware scanning product into Yahoo search.

The most dangerous websites are simply being removed from search results. Yahoo is also flagging less dangerous offending sites to warn users of specific problems that have been reported from those sites. Example warning messages include “Warning: Unsolicited E-mails” and “Warning: Dangerous Downloads.”

Site Advisor’s core product is a Firefox Add On that provides similar warnings to users. It’s similar to Haute Secure, which we have covered in the past. The Add On has been downloaded 135 million times, says McAfee.

The new feature is optional for Yahoo search users, although the default is set to on.

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“I’m extremely disappointed in Jerry Yang. I think he overplayed a weak hand. And I’m even more disappointed in the independent directors who were not responsive to the needs of independent shareholders.”
- Gordon Crawford of Capital Research, which owns 6% of Yahoo’s shares

The lawsuits are rolling in, and Yahoo’s biggest shareholders (see quote above) aren’t being shy about what they think of Jerry Yang and the Yahoo board of directors.

My guess is that Microsoft still very much wants Yahoo, they’re just trying really, really hard to make it look like they don’t. Now is their time to strike (again) as Yahoo’s shareholders are driven to make public comments like the one above out of sheer frustration.

If I were Microsoft, I’d place a new bid for Yahoo at $33 per share, and let the offer stand for three days. Yahoo’s shareholders are speaking quite publicly now that they think $33 is just fine, thank you. Yahoo’s board would have very little standing at this point to oppose it, with their stockholders making their position so clear.

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Citigroup Internet Analyst Mark Mahaney (our interview from last week is here) updated his Yahoo guidance today based on the Microsoft bid withdrawal over the weekend.

He sees Yahoo’s stock going to $22 if they continue with “business as usual” and don’t find a partner. This is 45% likely, he says. He gives a 40% chance that Yahoo pursues a major strategic alternative such as a Google outsourcing, partnership with AOL or MySpace, stock buyback, sale of Asian assets, etc. A Google outsourcing deal brings $1 billion of more in increased cash flow and adds $6 to Yahoo’s stock, he says.

He’s also saying that an eventual combination with Microsoft is still 15% likely. Microsoft may come back to the table, he says, because “there is No Plan B to succeed on the Internet” (I agree). The weighted average is a $26 stock price. Yahoo is currently (noon PST) trading at $24, down about 15% from Friday. It started the day down 20%.

Mahaney’s full chart is below. I’ve also added his top level analysis of a Google outsourcing deal. Search revenue would grow from $1.6 billion to $2.7 billion (moving from 4 cents a click to 7 cents).

Compare Mahaney’s $26 price guess to the Fred Wilson’s informal crowdsourcing approach, which came in at $22. If the markets stay steady, the real price is nearly exactly the mid point between the two.

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How black will today be for Yahoo’s shares? Following Microsoft’s withdrawal of its takeover offer on Saturday, shares of Yahoo took a 20 percent hit after the market opened this morning, opening at $23.02 (from Friday’s close of $28.67) but then started to edge up. That’s still well above the $19 per share that Yahoo was trading at when Microsoft originally made its offer three months ago.

If shares continue to drop, this could turn out to be a rough day for Yahoo shareholders. However, if the shares don’t drop much further, that could mean Wall Street is still pricing in another takeover attempt from Microsoft or someone else, or perhaps a Google advertising deal.

How low can Yahoo shares go, or is that it—a $5 drop?

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The most notable news this Sunday is what didn’t happen – no Yahoo/Google search deal was announced, meaning there is literally nothing standing between Yahoo and the unholy beating it is going to take when the markets open tomorrow morning.

Yahoo CEO did write a blog post on Yodel Anecdotal today that added to yesterday’s brief response to the Microsoft bid withdrawal. Upbeat in tone, it points to the many product announcements that Yahoo has made recently (Buzz, OneSearch 2.0, voice-activated mobile search, video on Flickr, Shine), product previews (AMP!, SearchMonkey) and the acquisition of Maven Networks.

He also suggested that Microsoft’s version of the negotiation timeline was “nonsense and misinformation,” countering that the Yahoo board “took its mission very seriously.” At this point, that’s really up for the lawyers to work out, as the shareholder lawsuits start to roll in.

Yang says that moving forward they’ll focus their energy on “growing our industry leadership and maximizing value for stockholders.” In many people’s opinion (including mine), they would have maximized shareholder value by simply accepting Microsoft’s offer back in February. Before all the costly severance arrangements, layoffs and high profile employee defections.

One thing Yang gets unambiguously right in his post is when he says “we know the spotlight will probably stay on us for a while.” that’s a certainty. All eyes are on Yahoo. If they stay independent, I certainly hope they nail execution and show that they made the right decision for their users and shareholders by declining Microsoft’s offer.

We’ll check back in tomorrow morning as the markets open to see whether the stockholders agree that Yahoo has “emerged a stronger, more focused company with an even greater sense of purpose” after this ordeal, or if they’re left a skeleton of their former selves, with shell shocked employees who don’t know up from down.

Yahoo’s glass may indeed remain half full. But the markets were expecting to see a Yahoo glass overflowing with Microsoft dollars tomorrow morning. A half full glass gets a half full stock price.

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As everyone digests yesterday’s extraordinary news around Microsoft’s withdrawal of their Yahoo bid, the big rumor around the valley is the Yahoo is frantically trying to negotiate a deal with Google to outsource search advertising and get it announced before the markets open tomorrow.

Yahoo-Google?

It’s not clear that Google still wants to do such a deal now that the immediate threat of a Microsoft/Yahoo deal is gone. The reason – the almost certain regulatory review (even Congress has taken note) And even if they are still willing to talk, Yahoo has lost the lions share of negotiating leverage. That means a lower revenue share, a shorter term deal, etc.

If Yahoo and Google reach a deal, it’s possible they could at least argue for a case that Yahoo’s value should increase to $37/share (but the markets won’t buy it): based on analyst projections, Yahoo could increase cash flow by $1 billion or more by outsourcing, and increase revenue per thousand search queries to as high as $90 from the current $40 or so. Combine that with massive headcount reductions (Yahoo won’t need their search marketing employees any more, possibly 2,000 employees), and Yahoo could have short term bottom line gains of well $1.2 billion or more/year.

With a trailing P/E of almost 40, That extra cash could, theoretically, boost their market cap by more than enough to reach their goal of $37/share.

That’s the theory anyway.

In reality, even if a deal is announced, the markets will factor in the risk of regulatory veto, as well as the long term negative effects of giving away the search marketing business to their biggest competitor.

And Yahoo’s true market value today remains in the $19/share range, or about $26 billion, now that the Microsoft crutch has ben removed. A good chunk of that – $10 billion or so – is actually from their Alibaba and Yahoo Japan holdings.

So Yahoo and Google may do a deal or they may not – but either way it isn’t going to help Yahoo’s share price as much as they hope.

Angry Shareholders

We also expect Yahoo to announce their delayed annual shareholder meeting early this week, and actually hold it as early as late June. When it’s announced, shareholders have ten days to propose an alternate slate of board members. Microsoft says they are sitting on the sidelines, but a group of angry stockholders may now emboldened enough to make their own effort to change company management.

To say that shareholders are angry is an understatement. They made it clear to anyone who’d talk to them that they would be more than happy with Microsoft’s $33/share final offer. Legg Mason, Capital Research, T. Rowe Price and others all reportedly strongly wanted the Microsoft deal to happen.

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Microsoft’s dramatic decision this weekend to withdraw its offer for Yahoo and not pursue a hostile bid raises a whole host of questions. What happens to Yahoo now? What happens to Microsoft? Or is this just a tactic to drive down the price of Yahoo’s shares so that Microsoft can go hostile with a lower offer? And if the deal really is dead, does Steve Ballmer need to start looking for a new job?

This last question may not be so hypothetical. Ballmer has been the big driver behind this deal at Microsoft—some would say to the point of obsession. After the disaster that has been Windows Vista (Microsoft’s core product), Ballmer may have realized he needed to redeem himself in the eyes of Microsoft’s board. And the “transformative” deal with Yahoo was the way he was going to do it.

One reading of Ballmer’s obsession with the deal is that he felt his job was on the line if he didn’t get it done. According to one secondhand account that leaked to us yesterday before the deal was called off, over the past week Ballmer increasingly has been “yelling and screaming at employees for almost no reason” and is being “more of a tyrant than usual.” One executive on the Microsoft deal team supposedly made a comment about “not having to worry about Ballmer anymore” if the Yahoo deal fell through. What the exec didn’t know, though, was that Ballmer was in earshot, and he screamed back that the deal would go through and that he wouldn’t let the board “crucify” him.

As things stand, the fact that Ballmer was not able to close the deal could put his job in jeopardy. The big questions are: If he really does walk away, can he put this distraction behind the company? Or is it too late for Ballmer? If Microsoft’s board loses patience with him, it might have to ask Blll Gates to temporarily come back as CEO until it finds a replacement. After all, Ballmer has already made a strong and convincing case for why Microsoft needs Yahoo to make its online and advertising strategy work (it needs the scale of Yahoo’s display and search advertising inventory to compete with Google). It is not clear how it can achieve its objectives on its own or through other acquisitions.

Maybe Ballmer backed down because he realized the deal was becoming too big of a distraction and he didn’t want to drag it out further given Yahoo’s continued resistance. (And save his job in the process). Or perhaps he thinks he can still get it done by making Yahoo’s stock price collapse and come back with a hostile offer. (After all, if you are going to go hostile, you’d want to drive down the stock price of the target company to make your offer look even more attractive to shareholders). We’ll find out later this week.

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Summary Of Today’s News: Negotiations between Yahoo and Microsoft, widely expected to result in a negotiated deal by Monday, fell apart today. There were a number of statements, all summarized below. Steve Gillmor also convened a special session of the Gillmor Gang at 7 pm to analyze the news – The transcript is still being created, but the recording is now up and live.

Listen to the special Microsoft/Yahoo Gillmor Gang here, with participation from Steve Gillmor, Michael Arrington, Doc Searls, Dan Farber, Dana Gardner, Robert Anderson, and Robert Scoble.

Today’s News (chronological):

1. Breaking: Microsoft Withdraws Yahoo Bid; Walks Away From Deal: Microsoft withdraws their February 1 offer, won’t go above $33/share and Yahoo wants $37. The post also includes a letter from Microsoft CEO Steve Ballmer to Yahoo CEO Jerry Yang delivered today.
2. Email From Steve Ballmer To All Microsoft Employees: Leaked email from Steve Ballmer to all Microsoft employees that we got our hands on. He explains the deal news to the troops.
3. Yahoo’s Tough Week Ahead: Yahoo faces a bleak world next week; look for the stock price to tank. Do they have a backup deal with Google?
4. Yahoo Responds: “The distraction of Microsoft’s unsolicited proposal now behind us”: Yahoo issues a press release suggesting relief that the pesky Microsoft distraction is behind them.
5. Optionally, skip all the above and just read CNET’s cartoon summary of today’s happenings:

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Yahoo issued the following press release responding to the breakdown in today’s Microsoft negotiations (interesting that Chairman Roy Bostock is taking center stage here, not CEO Jerry Yang). As we said earlier, this is just the beginning of a very long week for Yahoo.

Yahoo! Issues Statement in Response to Microsoft

SUNNYVALE, Calif., May 03, 2008 (BUSINESS WIRE) — Roy Bostock, Chairman of Yahoo! Inc. (Nasdaq:YHOO), a leading global Internet company issued the following statement today in response to Microsoft Corporation’s announcement that it has withdrawn its proposal to acquire Yahoo!:

“We remain focused on maximizing shareholder value and pursuing strategic opportunities that position Yahoo! for success and leadership in its markets. From the beginning of this process, our independent board and our management have been steadfast in our belief that Microsoft’s offer undervalued the company and we are pleased that so many of our shareholders joined us in expressing that view. Yahoo! is profitable, growing, and executing well on its strategic plan to capture the large opportunities in the relatively young online advertising market. Our solid results for the first quarter of 2008 and increased full year 2008 operating cash flow outlook reflect the progress the company is making. Today, Yahoo! has:

– a refined strategic focus to drive enhanced volume and yield;

– reorganized to focus its efforts on its most promising products and services;

– invested in innovations designed to revolutionize display advertising and facilitate closing the competitive gap in search; and

– enhanced expense and resource management to support improved profitability.”

Jerry Yang, co-founder and chief executive officer, Yahoo! Inc. added, “I am incredibly proud of the way our team has come together over the last three months. This process has underscored our unique and valuable strategic position. With the distraction of Microsoft’s unsolicited proposal now behind us, we will be able to focus all of our energies on executing the most important transition in our history so that we can maximize our potential to the benefit of our shareholders, employees, partners and users.”

About Yahoo! Inc.

Yahoo! Inc. is a leading global Internet brand and one of the most trafficked Internet destinations worldwide. Yahoo! is focused on powering its communities of users, advertisers, publishers, and developers by creating indispensable experiences built on trust. Yahoo! is headquartered in Sunnyvale, California. For more information, visit pressroom.yahoo.com.

Yahoo! and the Yahoo! logos are trademarks and/or registered trademarks of Yahoo! Inc. All other names are trademarks and/or registered trademarks of their respective owners.

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