After Yahoo's dramatic backpedal yesterday, investors are now assuming that Microsoft (MSFT) and Yahoo (YHOO) will come to an agreement--soon--at about $34 per share. Based on what has emerged about Steve Ballmer's mindset in past few days, however, we think this is less likely than the market thinks.

What The Market is Assuming:

Yahoo opened yesterday around $22.50, down $7, and Microsoft opened above $30, up more than $1. Why? Because the market initially assumed the deal was really off. (In the absence of any possibility of a deal with Microsoft, Yahoo would probably trade around $20-$21, but even yesterday morning there was some hope alive).

As the day went on, however, as Yahoo shareholders publicly spanked Yang & Co, there was increasing speculation that Yahoo would be forced to cave and that a deal would get done. And at the end of the day, Yahoo did cave, acknowledging that its $37 price demand was just a negotiating play and that it would be willing to sell for less.

On the surface, this makes a deal seem far more likely. But don't forget about what we've learned about why the deal talks collapsed.

What the Market is Missing:

Since Saturday, Yahoo has launched a PR offensive to try to get itself off the hook for blowing the negotiations. The message of this campaign is that Yahoo had demonstrated that it was willing to come down in price, moving from $40 to $37*, and that the negotiations were going fine--but that Steve Ballmer suddenly decided to walk. Also, Yahoo has said, Microsoft's bid increase to $33 wasn't really real because it wasn't delivered in writing.

Both of these details are designed to make Yahoo look less like a bunch of boobs, but as we wrote yesterday, both are also revealing. Here's the bottom line:

As of Saturday afternoon, Steve Ballmer no longer wanted to do this deal at any price.

That's why the $33 seemed "purposely vague"--because Steve wasn't really committed to it. That's why Microsoft walked just after Yahoo finally came to its senses and started to move on price. That's why Yahoo is now telling this story to anyone who will listen--because the mercurial Ballmer really did get over Yahoo.

(What Yahoo isn't saying, as it rolls out its global don't-blame-us campaign, is that OF COURSE Steve Ballmer is over this deal. For this merger to have a chance of working, both companies have to charge into it with 100% enthusiasm. For the past three months, however, Steve Ballmer has watched as:

1. Microsoft's shareholders and employees have peed all over the deal.
2. Yahoo has peed all over the deal.
3. Yahoo has done everything short of auctioning off the furniture to concoct ANY FUTURE BUT the deal.

None of which is conducive to 100% enthusiasm. If you were Steve Ballmer, wouldn't you have lost interest, too?

So the question is...what will Steve Ballmer do now?

Yahoo isn't the one one who has backtracked here--so has Steve Ballmer. He's just done it over the course of three months. (He's also done it for reasons that we consider sane and logical, but that's a different story.)

The question investors have to answer now is "Now that Yahoo is getting publicly spanked by irate shareholders and is showing a sudden willingness to deal, will Steve Ballmer change his mind again?"

If you assume Steve Ballmer walked because he just had a Saturday afternoon PMS episode, your answer is probably "Yes."

If, however, you assume that Steve Ballmer walked because, gradually, over the course of three months, he fell out of love with this transaction, your answer is probably "No."

We're in the latter camp.

See Also: Battered Yahoo Admits It Overplayed Hand, Ready For New Microsoft Talks