Boo-Hoo, ‘Microhoo’

After three months of trying to take over Yahoo! by carrot and by stick, Microsoft withdrew its carrot (a 60 percent premium over Yahoo's original stock price) and decided not to use the stick (getting its own directors elected to Yahoo's board). Last Saturday, in a letter apparently dictated through teeth gritted in frustration, Microsoft CEO Steve Ballmer wrote Chief Yahoo Jerry Yang that the assault was over. Now Microsoft is going to try and take on Google on its own.

Or will it? Here's a closer look at the disintegration of the deal and what it means for Microsoft, Yahoo and the Web's other major players.

Microsoft Yahoo's rejection comes at a crucial time for Steve Ballmer and his company: Microsoft's legendary chairman and co-founder Bill Gates will be leaving as a full-time employee in July. A $47.5 billion feint isn't an ideal curtain closer. Ballmer wasn't a lone voice in Redmond urging the merging; the entire Microsoft leadership team (including Gates) was eager to swallow the Yahoo operation. Still, the pressure is now on Ballmer to make sure that Microsoft, which still rakes in billions from its desktop business, maintains its vitality in the Internet-dominated future. In what must have been a tough self-evaluation, Microsoft came to the conclusion that it was necessary to spend almost $50 billion to bolster its Internet forces—an implicit acknowledgement of long-term failure in the online game—and now it's back to square one.

What now? There's still the possibility that Ballmer's move is more of a negotiating tactic than a bailout. After all, Microsoft was successful in getting Yahoo to agree that a sale was possible (the price turned out to be the final hurdle). If Yahoo stock gets stuck, Microsoft might be able to revisit the deal and get an even better price. On the other hand, Yang's refusal might have synced up with a realization on Ballmer's part that there's upside in walking away. Apparently a lot of the people at Microsoft (the ones who would have had to do the heavy lifting in the merger) thought that acquiring Yahoo was a mistake and the company would be better off without attempting a feat of integration beyond anything Microsoft had ever attempted. (Technology mergers have a miserable success rate. But Ballmer has to do something, because the conditions that led Microsoft to this drastic step are as dire as ever. Google isn't going away.

Yahoo Jerry Yang seemed ecstatic in his e-mail to all Yahoos in the wake of his successful defense of the company, gushing about how the exclamation point in the company name will be ascendant once more. (Though in a blog item he more solemnly noted, "No one is celebrating the outcome of these past three months … and no one should.") At every stage of this contest it was clear that for Yang the prospect of losing his company to Microsoft was worse than root canal without anesthetic. That's why he spent, according to Yahoo's recent quarterly results, $14 million on lawyers and advisers to help him fight Microsoft, and that's why he resisted Ballmer's good cop/bad cop routine until the end.

But now he's going to face complaints (and maybe lawsuits) from shareholders who will ask a reasonable question: what's the basis of his insistence that Yahoo is worth $37 a share or more when the actual marketplace (absent a live Microsoft offer) price is in the low 20s? Since the departure of former CEO Terry Semel (whose media focus helped the company in the short run but badly underestimated the Google factor), Yang is deeply involved in revamping the company. But he's not moving fast enough to impress Wall Street. One of the tactics Yang is experimenting with is an arrangement that allows Google to handle some of Yahoo's search advertising, which could be profitable. (Google has figured out how to make more money from search, a fact that doesn't speak well for Panama, Yahoo's expensive new ad system.)