Two months later, and we're back where we began: Microsoft (MSFT) bids $31 for Yahoo (YHOO), Yahoo counters with $40, and a price in the mid-$30s should get the deal done.

True, Yahoo had to explore other options. True, the possibility that Yahoo might blow Q1 could have led to a takeout below the original $31. But now all that's done.

Citi analyst Mark Mahaney upgraded Yahoo (YHOO) this morning, arguing that Microsoft won't walk away and will raise its bid to $34. We agree with the not walking away part, and we also agree with the raising the bid (at the 11th hour, when the companies are seriously negotiating). Thanks to Yahoo's apparent delivery of a solid Q1, we also still think a mid-$30s agreement is conceivable (though we wonder whether this would again be tied to Microsoft's stock price and therefore be variable). We just wish the companies would get on with it.

Mark Mahaney:

We Continue To View A MSFT-YHOO Deal As The Most Likely Outcome. We believe that a YHOO sale to MSFT - at a price likely higher than the initial $31 bid - is the most likely outcome. While regulatory risk may be material, we continue to believe that limited combined market share allows the deal to go through. And we would view YHOO strategic moves as a forcing function to a higher MSFT bid.

Why It Is Unlikely MSFT Will Walk Away - 1) Despite 3-4 years of making online advertising a key strategic priority, MSFT has yet to demonstrate traction - its share of U.S. Online Advertising was flat to slightly down in '07 (7.5% vs. 7.6% in '06); 2) Google's share of U.S. Online Advertising has significantly increased (35% in '06 to 40% in 07) & the DoubleClick acquisition could materially ramp its display ad biz; and 3) No other step could potentially address the scale/liquidity challenge of MSFT's ad platform.

Could There Be A YHOO Strategic Move Forcing Function? - While we continue to see no other competing bidders, we believe YHOO is aggressively pursuing strategic alternatives. One possibility is a tie-up with Time Warner, whereby TWX would contribute its Online Content assets to YHOO in exchange for a stake. We believe this could serve as a forcing function to a higher MSFT bid.

[We disagree--an AOL deal is just not a credible alternative, and we think Microsoft knows that.]

Our New $34 PT Reflects Our Scenario For An Increased MSFT Bid - We think the strategic value of YHOO to MSFT is very significant. $34 would also reflect a 16X EV/EBITDA multiple on our $2.2B 2009 EBITDA estimate (adjusted for YHOO's material $10.4B in off-balance sheet assets), which is below the company's recently stated $2.7B 2009 EBITDA goal and does not reflect any deal synergies. We view several deal multiples (aQuantive, Twenty-Four Seven Media, and Digitas) as all supporting a mid-to-high teens EBITDA multiple.

See Also: Hey, Yahoo, When's That Shareholder Meeting?