Yahoo Inc is not opposed to a deal with Microsoft Corp but will tell the software giant it has to make a better offer, a person familiar with the matter said on Sunday.
In a letter to be delivered on Monday, Yahoo's board is also expected to reject Microsoft's suggestion that its business is deteriorating, the person said.
Yahoo is responding to a three-week deadline issued by Microsoft Chief Executive Steve Ballmer in a letter to Yahoo on Saturday for Yahoo to agree to Microsoft's $31 a share cash-and-stock offer or risk seeing the bid lowered.
<b1>"This is a hardball tactic to turn up the heat on Yahoo's management to start negotiating immediately," Jeffries and Co analyst Youssef Squali said. He still predicts the Microsoft deal will be done at $31.
Directors of Sunnyvale, California-based Yahoo rebuffed Microsoft's original offer in February, saying it undervalues Yahoo and that it is seeking alternatives.
Meanwhile, talks on a potential alliance between Yahoo and Time Warner Inc's AOL have intensified, according to the person, who was not authorized to speak about the matter on the record. An AOL representative was not immediately available for comment. A Yahoo spokeswoman declined to comment.
Yahoo has also held talks with News Corp, but these talks have cooled, the source said.
Yahoo shareholders and analysts say Yahoo's options fall into two major categories; find an ally to help demonstrate Yahoo is worth more as an independent player or surprise the market with a strong show in its quarterly results.
The consensus on Wall Street is that no "white knight" will emerge to whisk Yahoo away from Microsoft and its proposed cash-and-stock offer currently valued at $42.2 billion.
Yahoo's management pitched the potential of alliances with Google Inc and AOL to shareholders as recently as last week as part of a roadshow to convince institutional investors that its business can thrive without Microsoft.
Yahoo executives also told investors that regulatory risks would undercut the value of any deal with Microsoft.
One investor said his firm met Yahoo management last week, and executives said they were "far along" in discussions with these companies.
Yahoo presented these alliances as a way to "monetize the different layers of their income statement," said the investor, who declined to be identified as the meeting was confidential.
Another investor, whose firm holds about 1 percent of Yahoo's shares, said Yahoo management recently spoke to them about the "value creating" potential of a tie-up with Google, centered on Yahoo outsourcing its search functions to Google.
A Google spokesman declined to comment.
COULD QUARTERLY RESULTS HELP YAHOO?
The Microsoft deadline falls on April 26, four days after Yahoo, and two days after Microsoft, reports quarterly results.
Given Microsoft's deadline, there is an outside chance Yahoo might choose to release its first-quarter results early as a way to demonstrate that, despite "headwinds" in its business, the company is finding strong pockets of growth.
Cowen and Co analyst Jim Friedland said a solid showing in quarterly results could turn a few investor heads, but is unlikely to answer medium and long-term questions hovering over Yahoo's strategy. He thinks Microsoft will get its deal done.
"If Q1 results are really good, can it change things? The answer is definitely yes. But there are lots of things working against that happening," Friedland said.
Yahoo's downbeat 2008 guidance issued in January was based on what the company knew before Microsoft made its offer. That bid has likely been a big distraction to business as usual over the past two months as sales people, product developers, even Yahoo advertising customers, wonder what the future holds.
"Here's the thing: Yahoo has never really had blowout quarters," Friedland recalls. "For people to say whoooaahh!!! Yahoo would have to see it meaningfully beat expectations like the kind of stuff Google was doing up until recently."
Ballmer's letter argued the economy, the market for Internet stocks and Yahoo's share of the search and advertising business have declined since Microsoft made its offer.
Microsoft's view of business conditions at Yahoo runs contrary to Yahoo's outlook. Last month, Yahoo forecast a rosy revenue outlook for the next two years.
(Additional reporting by Daisuke Wakabayashi in Seattle)