Updated at 6 p.m. PDT with comments from an institutional investor.
Microsoft on Saturday issued an ultimatum to Yahoo, giving the Internet search pioneer three weeks to enter formal merger negotiations and conclude a deal.
The software giant threatened to launch a proxy fight to unseat Yahoo's board of directors, as well as take its case straight to Yahoo investors should no deal be reached in that period.
And as a further cattle prod in getting a deal consummated, Microsoft threatened to lower its existing bid, citing how Yahoo's value will be hurt if it needs to resort to such hostile means.
"If we have not concluded an agreement within the next three weeks, we will be compelled to take our case directly to your shareholders, including the initiation of a proxy contest to elect an alternative slate of directors for the Yahoo board," Steve Ballmer, Microsoft chief executive, stated in his letter to Yahoo's board of directors. "The substantial premium reflected in our initial proposal anticipated a friendly transaction with you. If we are forced to take an offer directly to your shareholders, that action will have an undesirable impact on the value of your company from our perspective which will be reflected in the terms of our proposal."
Since its initial offer, executives from both companies met four weeks ago for the first time to discuss the merger and once again last week with no results of moving it into formal talks.
Yahoo's board is expected to discuss Ballmer's letter next week, as well as provide a briefing on how talks between the two companies went last week, one source said.
Ballmer's letter is no slam dunk in driving Yahoo to formal talks. Yahoo, which already rejected Microsoft's initial offer as too low and one that undervalues the company, is leery of entering formal talks without assurances Microsoft's bid will be higher.
"We could enter formal talks and they might increase the bid, or they might not," the source said, noting opening their financial books to the software giant may make little difference. "Our books are already open. We're going to report our earnings in a couple weeks."
Yahoo, meanwhile, is cognizant that Microsoft wants to get the deal done and past federal antitrust regulators, otherwise called the Department of Justice (DOJ), while President Bush is still in office, the source said.
One former high-level antitrust attorney with the DOJ, who is now in private practice, said it usually takes six to eight months to move a deal through the DOJ. There is approximately eight months left before Bush's term ends.
Meanwhile, another source noted back in early March that Microsoft has its opposition slate of directors for Yahoo all ready to go.
The opposition slate would move to unseat Yahoo's 10 directors at the next annual shareholders meeting. Should Microsoft take such action and prevail, it's likely the opposition slate would vote to remove Yahoo's "poison pill," which makes it prohibitively expensive to acquire the company. A poison pill floods the market with additional shares of a target company, should a hostile bidder acquire too many shares of a company's stock.
Ballmer, in his letter, indicated that Microsoft would ask Yahoo investors to tender their shares to the software giant, which would park them until it could get its opposition slate elected. While Microsoft would not be able to gain control of Yahoo by taking that measure, it will send a clear message to Yahoo if enough of the Internet company's investors side with Microsoft. Basically, it would show Yahoo how successful Microsoft would be in getting its opposition slate of directors elected, when those investors are asked to vote on Yahoo's new board.
Yahoo should brace itself for an onslaught of investor wrath come Monday.
One large institutional investor is planning to call Yahoo's independent directors and management on Monday.
"I'm not happy with how Yahoo has handled it. I think they've bungled it while Microsoft has played it pretty well," the investor said. "I like that (Microsoft) has put a clock on this. I previously told Yahoo's independent directors that if they didn't move forward with this, I might support a new board."
And while this investor had a brief thought of banning together a group of major Yahoo investors to make a public statement in support of Microsoft's bid, the institutional investor noted that there would be a number of filing hoops to go through with the Securities and Exchange Commission. He noted a more likely scenario will be for institutional investors to make individual statements.
The investor previously advised Yahoo to move forward and fast in doing a deal with Microsoft, given the changes in January with a new administration in the White House and in the European Union. He also advised Yahoo's management to ditch the idea of doing a roadshow with its three-year strategic plan, and instead spend the time getting a deal in place.
"We all think Microsoft should pay more for Yahoo and, if it is handled right, Microsoft will likely pay more," said the major investor, who thought $34 to $35 per share is a good range.
The investor added: "Microsoft has to do this deal. The paradigm is shifting away from their core business to the Internet. They've already spent billions of dollars but haven't gotten it right. This is such a logical deal for them to do."