Microsoft is walking away from its $42 billion unsolicited bid for Yahoo, capping three months of sometimes lax, sometimes intense, but always contentious negotiations between the two.
In a letter sent by Microsoft Chief Executive Steve Ballmer to Yahoo Chief Executive Jerry Yang late Saturday, Ballmer detailed his frustration at the process, but thanked Yang for spending time considering the deal.
Ballmer also confirmed in his letter that Microsoft did raise its bid by $5 billion, or $33 a share.
But Yahoo held fast to its position Saturday that Microsoft was offering too little to buy the company, and said it was pleased so many of its shareholders agreed with its determination.
"With the distraction of Microsoft's unsolicited proposal now behind us, we will be able to focus all of our energies on executing the most important transition in our history," Yang said in a statement.
Yahoo was holding out for $37 a share, according to sources.
Ballmer said in his letter than he thought a 70 percent premium to Yahoo's stock price the day before the bid was made public seemed like it should be attractive to the company.
In his letter (find it here), Ballmer also expressed deep concern at Yahoo's plan to align itself more closely with Google as a way to fend off a hostile bid from Microsoft. Aside from competitive concerns, and the power Google would yield over online advertising rates, Ballmer is deeply worried about how such an alignment would look in the eyes of Federal antitrust investigators.
Sources have said, and Google representatives have confirmed, that Justice Department attorneys began asking questions after Google and Yahoo launched a two-week ad-sharing trial partnership. Ballmer said in his letter that a deeper partnership would almost certainly raise antitrust red flags.
Analysts have said that if Microsoft walked away from the deal completely, Yahoo's shares would get torpedoed. Shares will be closely watched, especially after they rose nearly 7 percent to $28.67 on Friday as word of a sweetened Microsoft offer began to spread.
Laura Martin, a senior analyst at Soleil Securities, told Reuters Yahoo was demanding too high a price and she expected its shares to fall $8 on Monday when trading resumes on the Nasdaq.
"The Yahoo guys want too much money for their company. We think $33 a share is fair in the context of the weakening economic environment and adverse advertising trends," said Martin, who has a "hold" rating on Yahoo shares.
But a source close to Yahoo disputes Microsoft's claims that the internet search company was aloof in its negotiations following Microsoft's unsolicitied bid, and says Microsoft's own timeline shows an active negotiation process, whether Microsoft liked it or not.
Additionally, the source said there was never a "formal offer" of $33, just a suggestion that Microsoft would be willing to come up "a couple of bucks" on the offer. Nothing, he says, was every put in writing.
Yahoo will be under intense pressure to deliver on its promises and revive a stock price that had languished in the months leading up to the deal. And some even speculate that if Yahoo's turnaround efforts do not produce results and reinvigorate Yahoo's stock, the company could once again be in Microsoft's crosshairs.
Yang, who started Yahoo with co-founder David Filo in 1994 while they were graduate students at Stanford University, has projected that Yahoo's revenue will rise by 25 percent in 2009 and 2010, propelled by an expanded Internet advertising network that's using more sophisticated tools to target consumers.
But analysts haven't raised their forecasts to anywhere near Yang's predictions, reflecting doubts that could stoke a shareholder rebellion if it looks as if management isn't delivering on its promises.
On Saturday, Yahoo expressed confidence in the value of its company and the support of its investors.
"From the beginning of this process, our independent board and our management have been steadfast in our belief that Microsoft's offer undervalued the company and we are pleased that so many of our shareholders joined us in expressing that view," said Roy Bostock, chairman of Yahoo, in a statement released after Microsoft withdrew its bid.
Yahoo was resistant to Microsoft's overtures from the time the software giant made its proposal in February. (For a timeline of events, click here.) Yahoo had been negotiating with AOL, a division of Time Warner , and Google in what many viewed as attempts to thwart Microsoft's bid.
Microsoft says it will now go it alone in its online strategy.
"We continue to believe that our proposed acquisition made sense for Microsoft, Yahoo! and the market as a whole. Our goal in pursuing a combination with Yahoo! was to provide greater choice and innovation in the marketplace and create real value for our respective stockholders and employees," Ballmer said in a statement released by the company.
Analysts remain divided over how much Microsoft needed to complete the deal. While some viewed the potential tie-up as an expensive distraction that would help Google in lengthening its lead on Microsoft, others saw it as a way for Microsoft to quickly bulk up its presence in the all-important Internet space.
-- CNBC's David Faber contributed to this report.