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Alas, if Kara Swisher's sources are right (which it now appears they weren't*), the "alternative" transaction is Microsoft buying Yahoo's search business (which presumably means Panama plus a long-term monetization contract). At the right price, this would be a good deal for Yahoo: Its search business will continue to decline, with or without Panama, so it might as well get some money for its technology while it can. At almost any price, however, buying Panama would end up being a lousy deal for Microsoft.

*UPDATE: Both the WSJ and NYT make the deal sound like more of a search-monetization outsourcing arrangement, along the lines of the one Yahoo is pursuing with Google. WSJ:

According to people familiar with the matter, Microsoft has proposed a cooperative pact in which Yahoo would likely display advertisements sold by Microsoft alongside Web search results delivered to Yahoo's users. The intent, these people say, is to head off talks between Yahoo and Google Inc. over a similar relationship.

This makes more sense than Microsoft "buying Yahoo's search business." Given that Google likely generates a lot more revenue per search than even a combined Microsoft-Yahoo, however, Microsoft would presumably be "buying the business"--in the sense that it would be trying to outbid Google for the same arrangement.

"Buying" Search?

Buying Panama--the original report--would be a smaller mistake than buying Yahoo outright, but it still wouldn't be smart. We don't understand why Microsoft is so obsessed with competing with Google in search, but until we see some evidence that Microsoft or Yahoo can so much maintain query share, let alone gain it, we're going to regard all efforts in this direction as a lost cause. We understand that advertisers want an alternative to Google, and we know that Microsoft desperately wants to be that alternative, but we just haven't been persuaded that it has a chance.

Furthermore, although Yahoo would be smart to sell Panama to Microsoft, it would be dumb to give Microsoft an exclusive right to monetize Yahoo's search queries in perpetuity. Unless Microsoft agrees to pay per-query fees similar to those Yahoo could get by outsourcing search to Google, Yahoo would be better off selling its technology to Microsoft and then outsourcing its monetization to Google, which can generate significantly higher revenue per search than Microsoft. Of course, Microsoft would never allow this to happen, so we imagine a long-term monetization contract would be part of the deal.

In its statement, Microsoft took care to say that:

• It is still considering going it alone
• It might still buy Yahoo outright
• It might do nothing
  

And Yahoo is presumably still talking to Google (and even AOL).

On balance, we regard this latest development as positive for Yahoo and negative for Microsoft. Microsoft is clearly wigged out about the idea of a Google-Yahoo search partnership, and--given Microsoft's determination to compete in the search game--we can understand why. We also don't think Yahoo would be selling out its future if it sold Panama, because we think that future is gone.

Lastly, now that Microsoft and Yahoo are talking again, it is more likely that they'll find common ground for an outright merger--especially since Jerry Yang and Roy Bostock have had their fannies spanked and have already said publicly that they would be willing to sell the company for less than $37.

See Also: If Icahn Can't Get Microsoft Back to the Table, He'll Lose the Proxy Fight