What's behind Yahoo's rejection of Microsoft bid?

Yahoo's rejection of Microsoft's acquisition bid is likely a negotiating strategy to elicit a higher offer and shouldn't be seen as an attempt to resist a deal at all costs, according to analysts.

Neither Microsoft nor Yahoo has many options to improve their position in online services and advertising, and combining forces is their best bet against common rival Google, analysts said.

"It's part of a larger negotiation that's occurring. Clearly, Yahoo should be and is seeking a higher bid, and this is part of that process," said Clayton Moran, a financial analyst with Stanford Group.

Yahoo is unlikely to find a company willing to bid as much as Microsoft for it, while Microsoft will not be able to attain its Internet goals by acquiring a company other than Yahoo. "While they need to negotiate and go through the process, at the end of the day this deal will happen," Moran said.

On Monday, Yahoo rejected Microsoft's bid, saying it undervalues the company. Microsoft offered to pay $31 for half of Yahoo's outstanding shares and 0.9509 of a Microsoft share for the other half. At the time of the offer, Microsoft's stock stood at $32.60 and the bid was valued at $44.6 billion, a 62 percent premium over Yahoo's stock price at the time. However, the bid's value has dropped with Microsoft's sliding stock price, which at press time was $28.10. At the same time, Yahoo's stock price has risen from a close of $19.18 on the day before the bid to $29.75 at press time.

Moran predicted that Microsoft will adjust its offer so that it ends up at $35 per share, probably increasing the fixed cash portion and reducing the variable stock portion so that value is less vulnerable to Microsoft stock fluctuations. A $35-per-share offer would be a midpoint between the original bid and the $40 per share Yahoo is reportedly seeking.

"We continue to view a Yahoo sale to Microsoft as the most likely outcome," Citigroup financial analysts wrote in a note published Sunday after press reports over the weekend that Yahoo would reject the Microsoft bid. The rejection isn't surprising but rather is consistent with Yahoo's board job to "extract maximum value" for shareholders, the Citigroup analysts wrote.

Yahoo has reportedly held talks with Google and AOL to explore alternatives to a Microsoft acquisition. One scenario being floated would be for Yahoo to outsource its search advertising business to Google, while another, reported Monday by The Times of London, has Yahoo and Time Warner's AOL discussing a possible merger.

However, neither option would match the potential benefits of an acquisition by Microsoft, Moran said. "A combined Yahoo-AOL wouldn't be particularly strong, and Yahoo's stock wouldn't react favorably to that deal," Moran said. A search partnership with Google would boost Yahoo's revenue, but it wouldn't address larger problems within the company, he said.

For Moran, if Yahoo has approached AOL, it has done so probably to send a message to Microsoft that it has other options and that Microsoft has to sweeten its offer. Meanwhile, Google's intervention is probably directed at complicating and lengthening the negotiation process between Microsoft and Yahoo and thus delaying the formation of a stronger rival, Moran said.