Yahoo feeling the Microsoft nudge

Yahoo shares edged up Tuesday as analysts and the company's own major shareholder and director Carl Icahn said they longed for the Internet search pioneer to entertain a search-only deal with Microsoft.

That recommendation followed reports Monday that Yahoo and Google have dramatically watered down their initial search advertising proposal, as a means to gain approval from federal antitrust regulators.

Analysts with Sanford C. Bernstein & Co. said in a research note that Yahoo should dump its Google deal and turn its attention back to Microsoft, which previously had offered as much as $33 a share for the entire company and later came back with a search-only acquisition offer. Both deals were rejected by Yahoo.

Said Bernstein analysts:

We think the Google and Yahoo proposal to the DOJ, as reported in the press, to limit the deal to 25 percent of Yahoo's paid search revenues and to reduce the term of the deal from 10 years to 2 years is a desperate gambit that is likely to fail.

We expect the DOJ to defer a decision to next year and believe they are preparing for an antitrust showdown with Google. We expect the Google-Yahoo deal to founder, leaving Yahoo unable to acquire AOL's portal and stuck in a standalone value trap.

Under these circumstances we think that Microsoft might come back in the new year with a reduced bid in the region of $20/share...

And the Bernstein analysts are not alone in their hope for a Microsoft comeback.

Yahoo shareholder and director Carl Icahn, appearing Monday on CNBC, reiterated his hope of a Microsoft-Yahoo deal:

I have said publicly and will continue to say it...I believe, as a large shareholder...that eventually Yahoo should, if it's available, make a deal with Microsoft to sell the search business.

And while he doubts Microsoft is interested in buying all of Yahoo, Icahn noted that Yahoo could "save a fortune" if Microsoft operated its search business.

While the Redmond giant has yet to make any public moves in that direction, its CEO Steve Ballmer is still keeping an eye on the company. Just last month, Ballmer said during a Gartner keynote presentation that an acquisition of the company "still made sense" for Yahoo and Microsoft shareholders.

That sent Yahoo's share price on a rocket ride before Microsoft issued a statement that there were no talks going on between the companies and that the software giant had no interest in acquiring Yahoo.

As for Yahoo's shares Tuesday, the Internet search pioneer was up 4.7 percent to $13.35 a share in late afternoon trading.