SAN FRANCISCO -- Yahoo's rejection of Microsoft's unsolicited takeover bid left investors guessing the next move in a tense mating dance that may hatch a more imposing challenger to Google Inc. or disintegrate into a bruising brawl.
The rebuff, formally announced early Monday, wasn't a surprise, because Yahoo had leaked its intention over the weekend.
As expected, Yahoo's board unanimously decided to spurn Microsoft after concluding that the offer -- originally worth $44.6 billion, or $31 per share -- "substantially undervalues" one of the Internet's prized franchises. The cash-and-stock deal is now valued at about $40 billion, or $28.91 per share, because of a drop in Microsoft's market value.
But Yahoo didn't raise antitrust concerns about the proposed deal and added language that seemed to invite a higher offer from Redmond, Wash.-based Microsoft, the world's largest software maker.
"The board of directors is continually evaluating all of its strategic options in the context of the rapidly evolving industry environment, and we remain committed to pursuing initiatives that maximize value for all stockholders," Yahoo said in a statement.
Microsoft, though, didn't seem inclined to raise the bid Monday, releasing a statement describing its current bid as "full and fair."
While assessing its response to Microsoft, Yahoo's board also examined a wide range of alternatives that included forging an ad partnership with Google, which paid nearly $5 billion in marketing commissions to thousands of Web sites last year.
Without identifying its sources, the Times of London also reported that Yahoo is exploring a merger with Time Warner Inc.'s AOL, another popular Internet property that has been struggling in recent years. A Yahoo spokesman declined to comment on the report.
If Yahoo isn't sold, Chief Executive Officer Jerry Yang assured employees in a Monday e-mail that the company is poised to rebound on its own.
Investors appear convinced that Microsoft's bid remains Yahoo's best bet, given that the Sunnyvale-based company's profits have been steadily declining despite a management shakeup eight months ago and repeated promises of a turnaround extending back to 2006.
Reflecting Wall Street's belief that Microsoft will raise its bid, Yahoo shares climbed 67 cents Monday to close at $29.87. On the flip side, Microsoft's shares dropped 35 cents to finish at $28.21 as its shareholders continued to fret that a Yahoo acquisition could turn into more trouble than it's worth.
Microsoft's advisers are believed to be working behind the scenes to rally support among Yahoo shareholders and determine how much more the bid needs to be increased to force Yahoo's board to negotiate a friendly deal.
"You would assume that their first offer isn't the best and final offer," said Morton Pierce, an attorney who advises on mergers and acquisitions for the law firm Dewey & LeBouef. "The question now is how do you get to the end game?"
Analysts are convinced that Microsoft will raise its bid because it needs Yahoo to close Google's widening lead in the lucrative online search and advertising markets that are rapidly reshaping the technology and media industries.
Meanwhile, Yahoo finds itself in a bind because its stock was near a four-year low before the Microsoft bid surfaced, and its management has said things are unlikely to get significantly better until 2009.
"Both companies seem to have limited options to achieve their goals, so it appears they really do need each other," said Stanford Group Co. analyst Clayton Moran.
Although its profits have been dwindling during the past two years, Yahoo still possesses one of the Internet's biggest audiences and largest ad networks.
However, those assets haven't been compelling enough to persuade other potential buyers to counter Microsoft's bid, despite Yahoo's best efforts to drum up interest in the past week.
That could lessen the incentive for Microsoft to raise its bid.
But Yahoo wouldn't have had any chance of extracting more money unless its board had spurned the initial offer.
Microsoft was prepared to pay at least $40 per share for Yahoo a year ago, according to a person familiar with the earlier talks. Yahoo wasn't interested then because it was confident in its own strategy, said the person, who didn't want to be identified because Microsoft's 2007 offer never was publicly disclosed.
Making a higher bid now could accelerate the recent decline in Microsoft's market value, which has fallen by about $40 billion, or 13 percent, since the Yahoo offer.