How did the Great Yangini become Bizarro Jerry?

Jerry Yang's return to the helm at Yahoo! (NASDAQ:YHOO) started off with a bang, but the only thing his company is delivering these days is a whimper of false confidence.

I don't blame Yahoo! for crafting a response yesterday to potential acquirer Microsoft's (NASDAQ:MSFT) pointed missive over the weekend. Once Microsoft threatened to pull its offer within three weeks, taking the battle hostile at a probable lower price after that, Yahoo! had to respond. No one puts Yahoo! in a corner.

However, some of the passages of Yahoo!'s letter appear either unintentionally laughable or sadly ignorant of the reality that Yahoo! has carved out for itself these days.

Dark humor at a dark time
"Our position is simply that any transaction must be at a value that fully reflects the value of Yahoo!, including any strategic benefits to Microsoft, and on terms that provide certainty to our stockholders," the letter read.

To a cynic, that's practically an invitation to come back with a significantly lower bid, at a price comparable to the multiples that faster-growing peers such as Google (NASDAQ:GOOG) and parent IAC (NASDAQ:IACI) are fetching.

There's more: "Stockholders representing a significant portion of our outstanding shares have indicated to us that your proposal substantially undervalues Yahoo!."

If so, wouldn't there be a wave of buying among existing shareholders?

Then we get to what I find to be the most irksome point in the note, written by Yang and Yahoo! board Chairman Roy Bostock: "As a result of the decrease in your own stock price, the value of your proposal today is significantly lower than it was when you made your initial proposal."

Yahoo! is right. The value of the deal that was initially priced at $31 a share in cash and stock is now worth just $29.36 as of last night's close. However, where is the admission that most of the drop came immediately after Microsoft's offer was announced more than two months ago? The market punished Mr. Softy for overbidding for Yahoo!.

More to the point: Although the value of the offer has fallen by 5%, how can Yahoo! assume that its own value hasn't deteriorated much more than that? Google's stock has fallen by 16% in that time, and that's with research firms pointing out that Google has gained market share at Yahoo!'s expense since the deal was announced. Smaller search-engine stocks, including IAC and MIVA (NASDAQ:MIVA), have fallen by even more.

Let's make a deal
To Yahoo!'s credit, there is also a conciliatory tone throughout yesterday's letter. Yahoo! indicates that it has been willing to meet with Microsoft and would prefer a friendly buyout over a hostile takeover.

Yahoo! just finds itself in an awkward position. It turned down an offer that it should have accepted two months ago. The deal, meanwhile, becomes even more generous with every passing shot that the search-engine space is taking. The company seems ready to jump into Microsoft's arms, if Microsoft is willing to bend just a little.

South Park fans may recognize this as the point where all it would take is a Bennigan's coupon and some chewing gum to break the impasse, just so Yahoo! could save face. In other words, simply refreshing the deal so it would be worth $31 again could seal the deal.

The problem is that Microsoft shareholders have already suffered billions in market-cap hits in the pricey pursuit of Yahoo! Microsoft doesn't have the greenbacks to make an all-cash offer, and tethering the stock portion to a variable ratio based on a fluctuating share price sets Mr. Softy up for a fall if Yahoo! posts a bad quarterly report in two weeks.

In short, Microsoft may be able to afford a token upgrade, but why should it up the ante? It's in Microsoft's best interests to see Yahoo!'s hand come April 22 and then adjust its bid accordingly. If the report is good, Microsoft's stock will climb higher, since the assumption will be that Yahoo! has a better case for remaining a standalone company. The rise will also improve the value of the offer for a few days, until it's taken off the table. But if Yahoo! turns in a lousy report, Microsoft's stock will also climb, because investors know the company will either back out of the bidding for a fading company or else come back with a substantially lower offer later.

Microsoft is the one that can't lose by waiting at this point. Yes, it's accusing Yahoo! of dragging its feet -- something that Yang and Bostock deny -- but Mr. Softy is orchestrating the slow-mo buyout right now.

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