Yahoo Inc on Monday rejected Microsoft Corp's unsolicited $41.6 billion takeover offer as too low, forcing the software maker to either sweeten its bid or adopt a hostile approach to clinch a deal.

Analysts say Microsoft will probably raise its bid, originally valued at $31 a share, to at least $35, but could be persuaded to go as high as $40. Yahoo's statement did not suggest what price its board was seeking.

"The proposal is not in the best interests of Yahoo! and our stockholders," Chief Executive Jerry Yang wrote in an e-mail to employees on Monday. "We believe Microsoft's proposal substantially undervalues Yahoo!"

Yahoo said the offer did not properly assess its global brand, its audience of some 500 million users worldwide and investments in its online advertising platform.

The offer also does not take into account growth prospects or overseas holdings, which include a stake in Chinese e-commerce firm, the company said. Yahoo said its board was evaluating all its strategic options.

Microsoft now must decide whether to sweeten its offer, launch a proxy fight or, the least likely option, withdraw. A Microsoft spokesman declined to comment.
"The most likely outcome is they negotiate a higher price," said William Blair & Co analyst Troy Mastin. "It seems Microsoft has expressed a willingness" to go to $35 a share or $36 a share, he said.

A more hostile alternative could be to propose a tender offer to buy shares directly from Yahoo shareholders, although Yahoo could use a "poison pill" defense to dilute the stock holdings purchased in the market by an unwanted aggressor.

Microsoft could seek to replace Yahoo's board with directors more favorable to its point of view. Yahoo has set a March 14 deadline for shareholders to nominate directors.

"Acquisitions, especially in technology, are prone to high risk and high failure rates. Hostile transactions make it even more difficult for acquisitions to be a success," said Andy Miedler, technology analyst at Edward Jones.
"Microsoft clearly knows this."

RBC Capital cut its rating on Microsoft to "sector perform" from "outperform" and cut its target price to $31 from $40, saying the company would be distracted with the acquisition and extended integration with Yahoo if successful.

Microsoft shares were down 30 cents or 1.1 percent at $28.26 in afternoon Nasdaq trading. The stock has fallen 13 percent since the company went public with its bid for Yahoo, losing about $41 billion in market value -- close, ironically, to the amount of the bid.

Yahoo shares were up 62 cents or 2.1 percent at $29.82.


A merger of Microsoft and Yahoo would be the largest ever of two computer technology companies and would create a formidable rival to Web search leader Google Inc.

Microsoft announced the half-stock, half-cash offer on February 1. At the time, the bid represented a 62 percent premium to Yahoo's stock price. The offer was originally worth $44.6 billion, but is now worth $41.62 billion, or about $28.94 per share, following the decline in Microsoft's stock price.

Yang, who founded Yahoo with David Filo as a graduate student at Stanford University, has taken steps to try to keep the company independent, including considering an alternate tie-up in which Google would handle its search operations.

The company might also make a new approach to Time Warner Inc's AOL Internet division, the Times of London said on Monday. Time Warner declined comment on the story.

Yahoo shareholders may not have much patience for a drawn-out battle, particularly as the company continues to lose market share to Google. Yahoo last month disappointed Wall Street with its 2008 revenue forecasts, promising to cut jobs and shore up its Web advertising with new investment.

A dissident group of Yahoo shareholders said on Sunday it had launched a campaign to sell their shares as a block. Eric Jackson, leader of a group of shareholders representing less than 1 percent of Yahoo shares, said his group was prepared to negotiate separately with Microsoft or any other bidder.
In the e-mail to employees, Yang said Yahoo was well positioned to capture a larger share of a global online advertising market that is expected to grow to $75 billion in 2010 from $45 billion in 2007.

The letter, written entirely in lower-case letters to reflect the quirky corporate culture of the Web pioneer, said the company was seeking to drive a 15 percent per year increase in visits to and other central sites.
Yahoo is generating substantial operating cash flow, which gives it financial flexibility to pursue its plans, Yang said, targeting double-digit growth in percentage terms in 2009.

The company is seeking to keep its 14,000 employees placated as it girds for what is shaping up to be a potentially drawn-out, hostile takeover battle with Microsoft.

Goldman, Sachs & Co, Lehman Brothers and Moelis & Co are working as financial advisers to Yahoo; Skadden, Arps, Slate, Meagher & Flom is Yahoo's legal adviser. Munger Tolles & Olson is acting as counsel to Yahoo's outside directors.