Feb. 11 (Bloomberg) -- Microsoft Corp., whose $44.6 billion offer to buy Yahoo! Inc. was rejected today, will probably bypass Yahoo's board and take the bid directly to shareholders.

Yahoo's directors decided the price ``substantially undervalues'' the company. That refusal prompted a 2.3 percent gain in the stock today as investors anticipated a higher bid. The shares, which are trading above the offer price, may decline again if Microsoft doesn't raise the amount, making it easier for Chief Executive Officer Steve Ballmer to persuade shareholders directly, analysts said.

Microsoft, the largest software maker, may rely on hostile measures, a threat implied in a Jan. 31 letter to Yahoo's board, said Michael Gartenberg at JupiterResearch. Unless Yahoo CEO Jerry Yang has a plan to boost his company's shares above the offer price, Yahoo investors will side with Ballmer, he said.

``He essentially said, `We can do this the easy way or the hard way,''' said Gartenberg, a New York-based analyst. ``If Yahoo has no credible plan, it's hard to see how shareholders are going to say to Jerry, `It's your company and we'd love to find a way to keep it as a stand-alone entity.' I don't think that's a real priority for Yahoo shareholders.''

`Necessary Steps'

Microsoft sent its offer to the Yahoo board less than a day before making it public on Feb. 1. While the Microsoft bid was originally $31 a share, the value of the half-cash, half-stock deal has fallen to about $28.91, based on today's Microsoft share price.

Microsoft executives may now try to meet with Yahoo shareholders to get them to lobby the board. A person familiar with the matter said last week that the Redmond, Washington- based software maker may seek to oust Yahoo directors should they reject its offer.

In the letter, Ballmer wrote: ``Microsoft reserves the right to pursue all necessary steps to ensure that Yahoo's shareholders are provided with the opportunity to realize the value inherent in our proposal.''

Microsoft has never before made an unsolicited offer, let alone attempted a hostile takeover. Company spokesman Bill Cox declined to comment on the company's strategy.

By combining with Microsoft, Sunnyvale, California-based Yahoo would become a closer No. 2 behind Google Inc. in Internet advertising revenue and Web search queries.

Some Microsoft investors want to see the company hold firm on the price and make it clear that the software maker is willing to initiate either a tender offer to Yahoo shareholders or take over the Yahoo board.

`Hard Stance'

``Microsoft has to take a hard stance,'' said Ken Allen, an analyst at Baltimore-based T. Rowe Price Associates Inc., the fifth-largest institutional holder of Microsoft shares. ``If they immediately raise the bid, it would weaken their negotiating position.''

Microsoft probably won't do anything immediately and instead will bet that Yahoo shares will sink, making Ballmer's argument for him, according to analysts Charles Di Bona at Sanford C. Bernstein & Co. and Brendan Barnicle at Pacific Crest Securities. Microsoft's offer was 62 percent more than Yahoo's price before the bid.

``If it appears to shareholders that Microsoft might very well go away, the stock may do a bit of a swan dive here, and that enables Microsoft to come back in at the same price or a higher price,'' said Frederick Lane, the former co-head of mergers and acquisitions at Donaldson, Lufkin & Jenrette. He now runs Lane Berry & Co., a Boston investment banking boutique.

Slight Increase?

If Microsoft decides it can get the deal done more quickly by raising the offer slightly, analysts expect the company to move in that direction.

``They have the cash, and the investors who don't like the deal already sold the stock,'' said Portland, Oregon-based Barnicle, who rates the shares ``outperform.'' ``People who were fine with it at $31 a share will be fine with $33.''

Yahoo didn't say what price it would accept. The company wants at least $40, the Wall Street Journal reported Feb. 9. That's probably too high for Microsoft and its investors to stomach, Barnicle said.

``The Yahoo board may want whatever they want, but the stock was trading at $20 before the offer,'' he said.

Yahoo rose 67 cents to $29.87 at 4 p.m. New York time in Nasdaq Stock Market trading. Microsoft shares fell 35 cents to $28.21.

`$35 Tops'

If Microsoft wants to assure a reasonable return on its investment, the company can ``make $34 -- $35 tops -- work,'' said Di Bona, who is based in New York. Microsoft also needs to make sure it doesn't appear to be giving all the spoils to Yahoo's shareholders rather than its own, he said.

Yahoo's shareholders, on the other hand, may provide a useful ally for Ballmer. The company's stock had lost half its value in the two years before the offer. Eight months into Yang's tenure as CEO, he's failed to offer a plan to catch Google or reverse the stock declines, Gartenberg said. With no other bidders for Yahoo emerging so far, Ballmer's proposal may be the best choice available to Yahoo investors.

``The letter Ballmer wrote basically said, `Dear shareholders of Yahoo, would you like some of your money back? I'm prepared to give you that. Love, Steve,''' Gartenberg said. ``It's hard to see how this deal doesn't get done.''

Eric Jackson, president of the investment firm Ironfire Capital in Naples, Florida, is organizing shareholders to support the Microsoft bid or any higher offer, according to a posting on his blog yesterday. He said there are 2.1 million shares in support of the move, though the count is based on an ``informal pledge'' by investors.

To contact the reporters on this story: Dina Bass in Seattle at dbass2@bloomberg.net

Last Updated: February 11, 2008 16:39 EST