Yahoo Under the Gun After Microsoft Deal Collapses

Yahoo's shares tumbled as much as 20 percent after Microsoft withdrew its $47.5 billion takeover offer, wiping about $7.6 billion off the Internet company's market capitalization and piling pressure on its leadership.

In the aftermath, Internet search leader Google seemed poised to reap the gains of the missed deal, which would have been one of the biggest mergers in the technology sector and may have threatened Google's steady expansion on the Web.

Paul Sakuma / AP Yahoo! co-founder Jerry Yang

Microsoft shares rose 2.6 percent on relief that it was not willing to overpay for Yahoo, while Google rose 2.2 percent.

"The terminated Microsoft/Yahoo negotiations eliminate the risk for now of a stronger online advertising competitor to Google," Stifel Nicolaus analysts George Askew and Scott Devitt wrote in a research note.

They raised their price target on Google to $675 from $610.

Yahoo has been testing an advertising partnership that would give arch-rival Google part of its search listings.

While some on Wall Street see this is a potential way out for Yahoo, it also represents a new fringe benefit to Google.

The collapse of talks between Microsoft Chief Executive Steve Ballmer and Yahoo CEO Jerry Yang prompted Wall Street brokerages to cut their ratings and price targets on Yahoo, which held out for a $37 per share value despite a sweetened off from Microsoft for $33 per share.

Shares closed at $19.18 on January 31, the day before Microsoft made its unsolicited offer for Yahoo. Yang, one of Yahoo's founders, owns about 4 percent of the company.

Analysts expect a flurry of shareholder lawsuits against Yahoo management, even as the Web pioneer pursues possible deals with other Internet media and advertising companies, such as Time Warner's s AOL.

Yahoo is also likely to push for the Google partnership, sources familiar with the matter said.

That should boost Yahoo's operating performance in the near term, but runs the risk of regulatory scrutiny over an alliance between the Internet's top two players.

"Yahoo's execution remains the problem, as the company has not been able to execute better targeting and measurement on its own site effectively enough over the past 15 years," UBS analyst Heather Bellini wrote in a note to clients.

Bellini said she would not give Yahoo "the benefit of the doubt that they can make meaningful improvement over the next three years," especially as the break up of talks creates an even more competitive backdrop for Yahoo, Microsoft and Google.

Some of Yahoo's shareholders have already started to make their discontent public.

Bill Miller, a portfolio manager for Legg Mason, Yahoo's second-largest shareholder, told the New York Times on Sunday that he would have considered selling to Microsoft for $34 or $35 a share.

While that was more than Microsoft's offer, it was less than the $37 per share Yahoo's board insisted on.

"There is going to be a lot of pressure on Yahoo's management to deliver in the next year or two," Miller said, according to the New York Times.

To win the faith of shareholders, Yang will have to execute a turnaround plan that he began drawing up nearly a year ago after he replaced Terry Semel as CEO amid shareholder angst about the company's financial malaise.

Ballmer also will be under the gun to prove he can come up with another way to challenge Google's dominance of the Internet's lucrative search and advertising markets.

The unsolicited bid was widely seen as Ballmer's admission that Microsoft needed Yahoo's help to upgrade its unprofitable Internet division.

Analysts now expect Ballmer to use the money he had earmarked for the Yahoo acquisition to explore other possible deals with large Internet companies like Time Warner's AOL and News Corp.'s MySpace and promising startups like Facebook and LinkedIn. Microsoft already owns a 1.6 percent in Facebook, the second-largest social network behind MySpace.

But Ballmer is unlikely to be under as much duress as Yang, 39, who has promised that Yahoo's development of a more sophisticated and far-flung Internet advertising platform will produce net revenue growth of at least 25 percent in 2009 and 2010.

That would be a dramatic improvement, considering that Yahoo's revenue rose by 12 percent last year and is expected to grow at about the same pace this year.

Analysts, though, are skeptical about whether Yahoo will be able to hit those targets, raising the chances for a shareholder rebellion if the company stumbles in the next two quarters -- a distinct possibility if advertisers curtail spending in a shaky U.S. economy, as many analysts fear.

--Reuters and AP contributed to this report.

© 2009 CNBC