Yahoo investor guide to Microsoft's A, B, and C options

Updated at 12:25 p.m. PDT with details about Yahoo's share price.

Yahoo investors may see some interesting gyrations in the company's share price in the coming weeks, should the Internet pioneer and Microsoft fail to enter formal merger talks.

Microsoft issued an ultimatum to Yahoo nearly three weeks ago, demanding the Internet company enter formal negotiations by this Saturday, or face the prospect it could walk away from the deal, see a tender offer launched, and/or a proxy fight ensue, as outlined in its letter to Yahoo directors.

On February 1, Microsoft announced it had made an unsolicited bid, at the time valued at $44.6 billion, to acquire Yahoo. Redmond said it would pay a combination of cash and stock valuing Yahoo at $31 a share. Back on January 31, Yahoo shares closed at $19.18. After the offer was announced the following day, shares closed at $28.38. Yahoo's stock climbed as high as $30.25 in the two weeks that followed the offer and traded as low as $25.72 in mid-March. On Friday afternoon, Yahoo was trading at $26.41, down about 3 percent from the previous day's close.

Depending on which A, B, or C scenario Microsoft leads off with, the effect may be more sudden and dramatic to Yahoo's share price.

Here's a description of those scenarios and how they've played out in other corporate merger fights over price.

Option A: The walk away
The point of a walk away is to demonstrate to a reluctant seller that should the offer be pulled, the seller's stock will plummet to its prior trading levels--and then the buyer will return with its prior offer and look like a white knight. Trouble is, investors often don't believe it's the last that they'll see of that prospective buyer and it can take months for the stock to fall to its prior trading levels.

Yahoo investors need to ask themselves: How badly does Microsoft want Yahoo, and can the software giant afford the time it will take to wait for Yahoo's share price to fall to a meaningful level before stepping back into the picture?

Oracle tried that trick with its unsolicited bid of $17 per share for middleware software rival BEA Systems last fall. After BEA rejected Oracle's offer, stating it undervalued the company, Oracle gave a deadline to BEA to reconsider and come to the table, and pulled the offer when it didn't.

The trouble is, as in the case with the Microsoft-Yahoo deal, virtually everyone is expecting the suitor to return and with a larger bouquet of flowers, er, bid.

In the Oracle-BEA case, BEA's stock went from $13.62 a share on the day before the offer was announced to close that day at $18.82 per share. Roughly two weeks later, Oracle pulled its offer and the stock closed at $16.50 a share.

Over the course of roughly two and a half months that Oracle kept its bid pulled, BEA's stock fell as low as $14.76 a share. And while that was still a gain of more than 8 percent from where it was trading on the day before the offer was announced, it was still a far cry from the 38 percent gain its shares made the day of the announcement.

Oracle, with the help of BEA's largest individual shareholder, Carl Icahn, ended up doing a deal with BEA for $19.375 a share--more than a 42 percent premium above where the stock closed before the offer was announced.

Option B: The tender offer
A tender offer is a direct solicitation to investors of the target company. The purpose is to circumvent a reluctant seller and demonstrate that its investors support the price being offered by the "hostile" buyer. Often, the target company has an antitakeover measure in place called a shareholders rights plan, or "poison pill." As a result, investors are asked to only exchange, or park, their shares with the buyer until the poison pill is removed and then the shares can be tendered by the buyer. Usually a hostile buyer will run an opposition directors slate to unseat the current board and remove the poison pill. (A dissident slate of directors is option C, but we'll get to that later.)

Microsoft is threatening to go directly to Yahoo investors to win support for the deal, aka tender offer. That move would demonstrate Microsoft has a real offer on the table for investors to sink their teeth into, potentially giving Yahoo shares a pop--depending on what price Microsoft is offering for the "exchange."

Given Microsoft's comments over the past three months, however, don't be surprised to see a tender offer similar to what was offered to Yahoo. If Microsoft decides to up its bid as part of a tender offer, it would prompt the question: why didn't it initially go that route with Yahoo as part of a friendly transaction?

Investors shouldn't be surprised if Microsoft appears to have trouble showing a sizable commitment from Yahoo shareholders willing to tender their shares. Proxy solicitors, in part, say institutional investors are sometimes reluctant to park their shares, even if they support the price that's being offered, because it temporarily cuts into their flexibility to sell their shares as they see fit. Other investors, however, have no problem signing on.

One company that's in the midst of touting its tender offer is video game-publishing giant Electronic Arts. The game publishing behemoth launched its tender offer for rival Take-Two Interactive Software five weeks ago and recently announced it would extend the deadline for its "exchange offer" by one month.

Over the past five weeks that EA has had its tender offer out, approximately 8 percent of Take-Two's investors have tendered their shares. EA also lowered the buyout price to $25.74 a share from its initial offer of $26, stating the value of the $2 billion deal would remain the same but that the revised payout accounts for a restricted stock grant the company approved after EA made its buyout offer.

Option C: The proxy fight
A proxy fight calls for Microsoft to offer up a competing slate of directors to run against Yahoo's board at the Internet search pioneer's next annual shareholders meeting. The point of a proxy slate, in essence, is to get "your guys" elected, so they can carry out the desired goals that prompted the spurned buyer to launch a hostile fight to begin with.

Yahoo, which has yet to set a date for the annual meeting, has its entire board of 10 directors up for re-election for a one-year term.

With a proxy fight, it's like watching a presidential election, with major marketing efforts expended by both parties, to woo shareholders to their side of the ballot. Mud-slinging usually reaches levels where innocent bystanders should step aside.

If Yahoo has not yet called a date for when to hold its annual shareholders meeting by July 13, Microsoft can head to the Delaware Chancery Court and ask a meeting be called soon. Under the laws of Delaware, where Yahoo is incorporated, investors can approach the court 13 months after the target company's last shareholder meeting.

Once the Delaware Chancery Court makes a decision, it will generally require the target company to hold its annual meeting within 90 days after its ruling, Delaware lawyers say.

Microsoft's goal in getting its opposition slate elected is to get the poison pill removed and pave the way toward completing its acquisition of Yahoo.

Yahoo investors should keep in mind that Microsoft can roll out all three options in short order, or try the acupressure approach of applying pressure here, then there, and wait ample time for the results, before moving on to the next pressure point.