Yahoo will reject Microsoft's £22bn bid and say it undervalues the company

Yahoo is set to rebuff Microsoft's £22.4bn takeover bid for the search engine today and say it "massively undervalues" the company.

Microsoft made the unsolicited bid ten days ago in order to create a formidable challenge to the dominance of Google. But the Yahoo board is expected to write to Microsoft rejecting the $31-a-share offer as an attempt "to buy the company on the cheap".

Advisers to Yahoo are understood to be touting around an offer price of nearer to $40 a share – double the share price in January – and adding around £6.2bn to the value of Microsoft's bid.

But Yahoo will have to give valid reasons to shareholders for its rejection of the offer and come up with a value creation plan above and beyond what they stand to make if the tie-up were to go ahead. Its co-founder and chief executive Jerry Yang will have to find a strategy to revive a stock that has seen its value halve in the two years preceding the offer.

With the absence of any rival bidders, analysts believe that the Yahoo board might be prepared to sell once they have negotiated a higher price. One said that Microsoft is "well aware" Yahoo does not have any other options. Global Crown Capital analyst Martin Pyykkonen said: "Are they really seriously about nothing less than $40 or is it a negotiating tactic to try to get a richer price? To me, it sounds like a counter-negotiation tactic. Maybe they end up settling for $35, $36 or $37 a share."

Last week, analysts at Citigroup predicted that a higher bid was the most likely outcome but said $40 was "very aggressive" and that Microsoft would find it difficult to justify against Yahoo's expected cash flows. Citi-group said the offer at $31 was reasonable.

Yahoo, which is based in Sunnyvale, California, has spent years trying to catch up with Google's dominance in web queries and advertising revenue – the company has reported eight quarters of profit declines and a tie-up is looking like the only way to make it competitive.

A merged Microsoft and Yahoo would control more than a quarter of the market for animated ads and display banners at the top of internet pages. Analysts say that this would give the combined company a way to challenge Google, which has not made as much progress in that area.

But Mr Yang, who replaced Terry Semel as chief executive in June, has been reluctant to give up a company he co-founded in 1995, when he was a graduate student at Stanford University. Last week, it emerged that Yahoo was examining an alliance with Google as a last-ditch attempt to avoid being gobbled up by Micro-soft. Sources said Google contacted Yahoo within hours of Micro-soft's bid approach and was hoping to scupper a combination of its two closest competitors. Google was also reaching out to other media companies to encourage them to make a counter-bid.

Yahoo, which is being advised by Goldman Sachs and Lehman Brothers, is not expecting Micro-soft to go hostile to win the bid but reports have indicated that the software giant may try to oust the Yahoo directors if they were to reject the offer.

In a letter to Yahoo's board on 1 February, Microsoft's chief executive Steve Ballmer wrote: "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."

A spokeswoman for Yahoo said at the weekend: "Yahoo's board is carefully and thoroughly evaluating the Microsoft proposal in the context of all of the company's strategic alternatives."

According to data from US research firm ComScore, Google accounted for more than 58 per cent of internet searches in the US in December, with Yahoo on 22.9 per cent and Microsoft on just under 10 per cent.

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