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What now for Yahoo?

As the internet search engine company rejects Microsoft's offer, the market is left to speculate on the options still remaining to a firm under pressure from shareholders

So that's forty-five billion from the balding man in the jumper, do I hear fifty? Fifty, from the balding man in the jumper, do I hear fifty-five? Fifty-five from the balding man in the jumper, do I hear sixty? Sixty, going once, going twice. Sold. To the balding man in the jumper.

Will the Microsoft chief executive Steve Ballmer bid against himself to win control of Yahoo? This was the multi-billion dollar question yesterday, after Yahoo rejected Microsoft's offer for the ailing internet giant. Investors were betting yes.

In the 10 days since Mr Ballmer wrote to his opposite number at Yahoo, Jerry Yang, proposing a takeover deal then worth $45bn (£23bn), the internet company's advisers have been frantically searching for an alternative deal that could trump Microsoft's offer. The odds of that are being put as low today as they were on day one.

And yet Mr Yang yesterday sent Mr Ballmer away with a flea in his ear. In a Yahoo statement to shareholders and a personal e-mail to staff, Mr Yang insisted that Microsoft's cash-and-shares offer substantially undervalues the company and accepting it would not be in the best interests of Yahoo or its shareholders.

"The global online advertising market is projected to grow from $45bn in 2007 to $75bn in 2010, and our more focused strategies position us to capture an even larger share of this market," he told staff. "Our global brand is a tremendous base from which to build leadership as the starting point for internet use: Yahoo is one of the most

recognisable brands in the world. We have some 500 million users (one out of every two internet users worldwide). In the US we are number one in personalised home pages, mail, music, news, sports, shopping and travel."

It was a rousing defence of Yahoo's existing business plan – a business plan that the stock market was valuing at less than $20 a share the day before Mr Ballmer pitched up.

Yahoo shares closed yesterday at $29.87, some 3 per cent higher than the value of the Micro-soft offer (which has fallen from its original $31 per Yahoo share because Microsoft's own stock has fallen sharply). Buyers of Yahoo shares at this point are largely betting that Mr Ballmer will agree to up his bid by at least 2.5 per cent.

Microsoft put out a holding statement last night, saying Yahoo's response was "unfortunate" and that its conversations with Yahoo shareholders gave it confidence to keep pressing for a deal. "As we have said previously, Microsoft reserves the right to pursue all necessary steps to ensure that Yahoo's shareholders are provided with the opportunity to realise the value inherent in our proposal," it said.

That Mr Ballmer absolutely intends to prevail is not in doubt. Now he needs to decide whether to go hostile, threatening to try to oust the existing Yahoo board, for example, and risking alienating the 14,000 Yahoo employees he will need to woo to effect a difficult integration.

By hitching together Yahoo's network of internet sites and its own MSN internet business, Microsoft hopes to be able to offer a better deal for advertisers. On top of that, Yahoo and MSN together would be able to offer better coverage to corporations who want to place their ads against search engine results. Microsoft believes its ad targeting technology would be better at squeezing more money from advertisers, who pay only when a user clicks through to their site. Yahoo has just invested heavily in its own new technology, called Panama, which has improved profitability but is still not matching Google's click-through rates.

Yahoo's shareholders are already starting to agitate for a deal, conscious that it could take years for their shares to return to the level of the Microsoft bid if the company opts to remain independent. Last night, Larry Puglia, fund manager at T Rowe Price – Yahoo's 12th biggest shareholder – became the first to publicly call for an agreement and said he would become "very vocal" if Microsoft upped its offer. Mr Ballmer met fund managers at Yahoo's largest shareholder, Capital Research, last week. All the smoke signals are that shareholders will push Yahoo into an agreement if Mr Ballmer moves even a penny or two, and few investors are hooked on the $40 per share valuation that Yahoo insiders said they were holding out for.

There has been such a high volume of trading in Yahoo stock since the Microsoft bid was announced that it is possible up to half the company has changed hands, and speculative investors are much more likely to push for a deal. Any of the older investors or the new funds could emerge as an honest broker for a deal, observers said.

To justify $40 as an independent company, Mr Yang will have to pitch a big new idea, perhaps a merger with AOL, or a deal to outsource its search-based advertising sales to Google. That could immediately add 25 per cent to earnings, some analysts calculate, but might attract the attentions of competition authorities.

Mark Mahaney, Citigroup's technology analyst, told clients: "It's the board's job to extract maximum value, and Microsoft's 62 per cent bid premium was on a four-year low stock price. While we are sceptical that Yahoo is intrinsically worth $40 per share, we believe its strategic value to Microsoft is substantial. Buying Yahoo may be its only game changing option."

Brad Reback, analyst at Oppenheimer, said: "We do not expect a rival bidder to emerge for Yahoo as Microsoft is best positioned to pay the highest price and has the most to lose should the asset fall into the hands of another company."