Yahoo rejects Microsoft bid

By Daisuke Wakabayashi and Eric Auchard

SEATTLE/SAN FRANCISCO (Reuters) - Yahoo Inc rejected Microsoft Corp's unsolicited $41.6 billion takeover offer as too low on Monday, forcing the software maker either to sweeten the bid or adopt a hostile approach to clinch a deal.

Microsoft responded by calling its offer full and fair, but stopped short of saying it would not raise its offer. Microsoft said in a statement it reserves the right "to pursue all necessary steps" without specifying whether it plans to take its bid straight to Yahoo shareholders.

Still, 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."

Microsoft wants to complete the largest-ever computer technology merger in a bold strategic move aimed at creating a formidable rival to Web search leader Google Inc.

Yahoo said the offer did not properly assess its audience of 500 million users worldwide, investments in its online advertising platform and its ability to generate cash.

The offer also does not take into account growth prospects or overseas holdings, which include a large minority stake in Yahoo Japan Corp, the company said. Yahoo said its board was evaluating all its strategic options.

Redmond, Washington-based Microsoft now must decide whether to sweeten its offer, launch a proxy fight or, the least likely option, withdraw.

"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.

Yahoo shares rose 67 cents, or 2.3 percent, to close at $29.87. The stock is now trading at a 3.3 percent premium to Microsoft's cash-and-stock deal value, indicating investors are expecting Microsoft to raise its bid.

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 fell 1.2 percent to $28.21 in Nasdaq trade. The stock has lost 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.