• by Wendy Davis , Staff Writer @wendyndavis, May 5, 2008

Talks between Yahoo and Microsoft might have ended this weekend, but the overall Silicon Valley landscape still appears very much in flux.

Microsoft stunned the online ad world three months ago by offering to purchase Yahoo for $31 a share -- a premium of more than 60%. When Yahoo responded that the price was too low, many analysts saw the move as a negotiating tactic. Indeed, as late as last Friday, many observers believed a deal between the two companies was all but inevitable, and were certain that the companies would reach a middle ground on price.

But Microsoft, and some analysts, seemed to have underestimated Yahoo's distaste for being acquired by Microsoft. In fact, Yahoo was so resistant to joining the software giant -- which had raised its bid to $33 by Saturday -- that the company decided it would rather deal with search rival Google.

The companies last month tested an alliance that involved Google powering 3% of search ads on Yahoo. By last week, when it still looked as if Microsoft might launch a proxy war to wrest control of Yahoo, rumors swirled that Yahoo and Google were poised to enter into a longer-term search alliance. Antitrust authorities might scrutinize such a deal, but that doesn't mean they would scuttle it.

The last thing Microsoft wanted was to merge with Yahoo but then be contractually bound to allow Google to serve search ads for the property -- and Microsoft CEO Steve Ballmer said as much Saturday in a letter to Yahoo. "We regard with particular concern your apparent planning to respond to a 'hostile' bid by pursuing a new arrangement that would involve or lead to the outsourcing to Google of key paid Internet search terms offered by Yahoo! today," he wrote. "In our view, such an arrangement with the dominant search provider would make an acquisition of Yahoo! undesirable to us for a number of reasons."

As of Monday morning, it's not clear whether Yahoo and Google will go through with plans to work together on search ads. But neither company has ruled it out. Further roiling the online ad industry, AOL is once again in play -- and in discussions with both Yahoo and Microsoft, according to press reports.

Meantime, Yahoo's Jerry Yang will almost certainly need to fend off shareholder lawsuits, as the stock plunges to something closer to its pre-Feb. 1 trading price of $19 a share. Of course, a sharp drop-off in trading today doesn't mean the stock will take a long-term hit. But Yang and the rest of the Yahoo board are obviously now under tremendous pressure to prove that the company is worth more than the $33 a share they turned down.