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Things are heating up between Yahoo! (YHOO) and Microsoft (MSFT) as Yahoo! rejects Microsoft’s offer of $31 per share. Yahoo! is standing its ground, insisting that Microsoft up the ante by $44.6 billion. Indeed, there are somewhat compelling arguments Yahoo! is making, pointing out that it is worth more than $31 a share:

• Yahoo! insists that optimistic outlook through 2010 is legitimate.
• Yahoo! insists that it is on track to hit its estimates, even with the economic slowdown on.
• Yahoo! is bringing up anti-trust issues.
• Yahoo! points to its new ad revenue system as something to add value.
• And, finally, Yahoo! points out that Microsoft stock has fallen, and so the offer is worth less today than when it was made.

These are interesting points. And Microsoft may or may not address them. But, in the end, reasoned negotiation is not Microsoft’s style. As seen in its strong-arm letter threatening a hostile proxy takeover if Yahoo! doesn’t fold. Besides, who else there for Yahoo!? The company needs some sort of a boost for it to truly take on Google.

Here is what Justin Post, an analyst at Merrill Lynch, wrote about the Yahoo! and Microsoft tangle in a research note:

Yahoo’s inability to find a credible alternative and Microsoft’s weakening stock price since the deal was announced make a substantial increase in the offer price much less likely, in our view. We believe a deal, however, is still likely based on the rationale that search is a scale game, Yahoo! is still losing usage market share (despite positive monetization trends), and Microsoft needs to bolster their online advertising capabilities as computing becomes more Net-centric. Yahoo’s “white knight” scenarios and aggressive three year EBITDA projections have been viewed as somewhat unrealistic by most investors.

So, even though Yahoo! insists its projections are legit, there is still plenty of speculation to the contrary.

In the end, both Microsoft and Yahoo! appear to need this deal to go through. But Yahoo! may be in the position of weakness. After all, after all the words that have been flying back and forth, YHOO is down and MSFT is up.

(image credit: Brady Wood)

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