Shake your head at Microsoft's Internet futility all you want, but Steve Ballmer & Co. have won the latest round hands down.

True, this victory has come not through brilliant action, but brilliant--or at least fortunate--inaction. But as Warren Buffett is fond of noting, sometimes doing nothing is the smartest move you can make.

Ten months ago, Steve Ballmer was on the verge of handing over $50 billion of stock and cash for Yahoo, a deal that would have diluted the hell out of Microsoft shareholders, bought Microsoft a dying elephant, and ultimately have been a disaster. Fortunately, Yahoo sniffed at the offer.

Six months or so ago, Ballmer tried twice to buy Yahoo's search business, after Yahoo rushed to Google to negotiate a lucrative search partnership to stave off the Microsoft acquisition bid. The second offer, which still wasn't quite as good for Yahoo as the Google deal, would have paid Yahoo to permanently exit a business it has already lost (search engineering). Again, fortunately, Yahoo sniffed at the offer.

And now Yahoo's stock has fallen to $12, ad spending is heading into the tank, the Google-Yahoo search partnership is all but dead, and Yahoo board members are trying to rekindle search talks with Microsoft. Yahoo is also firing 1500+ employees, restructuring its business, and mired in endless negotiations with Time Warner over the fate of AOL.

So, what is likely to happen?

We would not be surprised if the following plan was being bandied about the executive suites in Redmond:

Let the Yahoo-Google deal fail. This will destroy any last bit of leverage that Yahoo has in a search negotiation. A new Microsoft-Yahoo search deal would already have far better terms (for Microsoft) than Microsoft's second offer last summer. The abandonment of the Yahoo-Google deal will remove any pretense of another Yahoo option. Let Yahoo buy AOL and try to integrate it. Given that Jerry appears to be choosing a death-by-a-thousand cuts restructuring strategy for Yahoo, it seems unlikely that he'll have the resolve to do what has to be done if Yahoo buys AOL, which is fire at least 4000 people from the combined company. As a result, the deal will probably be a disaster. Buy the wreckage for $15-$20 a share (or less, depending on what happens to the business over the next six months).

Six months down the road, Google's position will be even more dominant, so regulators would probably wave a deal like this through. Microsoft would still have major challenges running the business (we would recommend a spinoff of all the Internet operations as a separate company), but global advertisers would be screaming for a viable Google alternative, and combining the operations of Microsoft, AOL, and Yahoo would give them one.

See Also: Google Threatens To Stick Fork In Yahoo Deal