A company with a history of overpaying lost a great deal when it couldn’t force Microsoft to overpay. Now what?

Illustration by Mark Alan Stamaty. Click image to expand.

It is axiomatic in the online world that no one knows what anything is truly worth. Yet for practically all of its corporate life, Yahoo has been comfortable with the answer: It’s worth more.

That perspective has gotten Yahoo into trouble, certainly when it sat on the buying side of the table. Think back to early 1999, when Yahoo purchased GeoCities, a service that allowed users to build their own Web pages. Given that GeoCities at the time had 3.5 million users, it was not unreasonable to think that it was worth more than nothing, even though its mounting losses were about $8 million a quarter. To say that it was worth $5 billion took a supreme act of hubris—but that’s what Yahoo paid in a stock swap. (Technically, GeoCities still exists, almost as a museum piece.)

Later that year, Yahoo bought the Web-radio outfit from brash entrepreneur Mark Cuban for, yes, $5 billion. Cuban is still with us, but is long gone, and Yahoo’s audio services are either shuttered or also-rans. Again, you could make the case that Yahoo got some kind of value out of Broadcast’s technology—but could almost certainly have found it elsewhere for less than one-tenth of that sum.

Over the weekend, Yahoo experienced the downside of hubris from the other side. On Jan. 31 of this year, the stock market thought Yahoo was worth $19.18 a share, or a bit more than $25.6 billion. The next day, Microsoft announced its intention to buy Yahoo at $31 a share, or $44.6 billion—62 percent more than what the market said the company was worth a few hours earlier.

Many people would look at a 62 percent price bump and say, That’s a good deal. Yahoo said, It’s worth more. The board sniffed that Microsoft’s offer “substantially undervalues” the company. Maybe this stance was a good negotiating tactic; maybe it was a bluff. The thing about a bluff, though, is you don’t want to be caught before the other guy folds.

Microsoft came back and sweetened its offer to $33 a share, and Yahoo said: It’s worth more. That’s when Microsoft’s Steve Ballmer decided to walk away from the table. So, as of today, Yahoo is trading at below $25 a share, or an overall value of less than $33 billion.

No doubt there are some heavy Yahoo shareholders who simply didn’t want to give up their independence to the Dark Star of Redmond, but such prejudice is no long-term substitute for strategy. What Ballmer and just about everyone else could see is that Yahoo failed to make the case that it has a plan for future growth. Yahoo’s net income declined in both 2006 and 2007. For years, Yahoo has watched as Google snatched the momentum from Yahoo’s greatest strength—search. In response, Yahoo hyped for more than a year an ad service called Panama that was supposed to compete with Google’s AdSense. Panama may some day prove valuable, but Yahoo’s announcement last month that it would begin testing a version of AdSense—in which Google ads would appear alongside Yahoo search results—was practically an admission that Panama has failed. And Yahoo’s arguments that it would help turn Microsoft into an Internet ad giant both in the United States and abroad brought little more than embarrassed grimaces from most seasoned observers.

There are focus problems, too. Yahoo over the years has acquired a thicket of Web properties that it doesn’t seem to know how to handle. Some of these—like photo service Flickr and social bookmarking site—are cool Web 2.0 tools that may yet find productive ways to integrate into Yahoo’s broader business. Others are wooly legacies—like MusicMatch and auction sites in Asia—that no longer seem to fit with what Yahoo does. When Yahoo co-founder Jerry Yang took back the CEO seat last summer, he promised a fresh look at the company’s strategy, but aside from laying off 1,000 workers earlier this year, nothing has emerged.

So what are Yahoo’s options now? Yang needs a plan, and fast. The $14 billion of shareholder value that evaporated this morning is going to attract lawsuits, and fast. Yahoo has played footsie with other Web companies, including Time Warner’s AOL and News Corp.’s MySpace. But neither of those deals was an outright purchase that could rival Microsoft’s offers. Some hold out hope for a deal with Google, though it’s hard to see what Yahoo has to offer Google. Paul LaMonica of CNN Money makes the case this morning that Yahoo may find itself crawling back to Microsoft, much as BEA Systems was ultimately bought by Oracle in January after months of squabbling and an Oracle walk-away. If such a deal happens at less than $35 a share—which is the only imaginable way—it might finally put an end to Yahoo-bris.