Ballmer Balks. Now What for Microsoft?

It could aim its billions at other targets, including AOL.

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Microsoft walked away from Yahoo over the weekend. Is the deal really dead? And if so, what's Microsoft CEO Steve Ballmer & Co.'s next move?

Here's a look at the options.

Microsoft bides its time. "Despite the withdrawal of the offer, we are not convinced that MSFT is going away for good," writes David Hilal at Friedman Billings Ramsey.

Any weakness at Yahoo makes it easier for Microsoft to swoop back in with its $33-a-share bid in what is generally agreed to be Microsoft's best option of catching up to rival Google in the online advertising fight.

"Yahoo really has to step it up here, hold on to the viewers they have, and demonstrate they can get ad dollars," says Kim Caughey, a tech analyst at Fort Pitt Capital Group.

Expect shareholders to ratchet up the pressure on Yahoo's board as the company's share price slumps. Shares were off 16 percent in early trading.

Microsoft goes on a buying binge. CEOs at dozens of popular search and social networking start-ups undoubtedly woke up excited today.

At any rate, analysts say Microsoft has to do something. Citigroup analysts "continue to see no Plan B" for Microsoft if the Yahoo deal is truly dead. They say smaller acquisitions in the Internet advertising sector could be a next step. Blogs are already buzzing with possible names big and small, ranging from MySpace and Facebook (where Microsoft already has a stake) to Twitter and Digg, with wild cards like Meebo and Ning thrown in for good measure.

That road could be a tough one, too, analysts note. RBC Capital analysts write that "the alternative option of cobbling together a number of acquisitions totaling +$40B would not likely bring as much scale as with Yahoo and would bring a number of integration headaches even beyond a MSFT/ YHOO merger."

Microsoft buys AOL. Buying Time Warner's AOL makes sense only in that it would give Microsoft a second-tier version of the Yahoo deal. It would push Microsoft closer to its desired 25 percent share of the digital advertising market.

Analysts estimate AOL has about an 8 percent share, which would double Microsoft'scurrent presence.

Susquehanna Financial analysts say an AOL bid is a possibility for either Yahoo or Microsoft given the lack of sizable alternatives in the online ad market. In any case, AOL is at best the biggest of several less-than-spectacular options. From Susquehanna:

Looking at the marketplace, there is no real alternative for Microsoft in the search market unless it looks to bolster its share indirectly by aggregating smaller search engine marketers. However, AOL might give it a significant lift in the branded ad market.

Back to the drawing board. Microsoft could keep trying to catch Google by recruiting new talent and continuing to invest in its own hiring and research and development. But that won't come cheap. Cowen analysts note that while Microsoft has ramped up spending at its online unit, it's still expected to spend just half of what Google does in the 2009 fiscal year. Increasing investment to match Google's would shave 30 cents off of '09 earnings.

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  • Kirk Shinkle

    Kirk Shinkle is a senior editor for U.S. News Money and manages the Best Funds portal. Follow him on Twitter @KirkS or email him at kshinkle@usnews.com.