Is Google ad deal really Yahoo's best option?

Now might be a good time for Yahoo to show some evidence of the merits of all those "strategic alternatives" it's been pursuing.

On Saturday, Microsoft formally withdrew its offer to acquire the search pioneer, at least for now. So what happens next for Yahoo?

There are a handful of clear options: stick to the current plan, strike a deal with Time Warner to acquire AOL, or outsource some search advertising to Google.

This last option is certainly on the short list of possibilities: Yahoo conducted a two-week test that used Google's higher-revenue system for placing text advertisements next to search results. Gartner analyst Allen Weiner sees it as the most likely future for Yahoo.

"Google is the powerhouse that could turn them," he said. "Yahoo is still the No. 1 Web traffic company in the world, and Google is the No. 1 search and ad company. That's an interesting combination. If they could figure a way to work together and work within the law, I think that's their best bet."

But relying on Google for ads, even in a limited way, is in effect admitting defeat in a key part of Yahoo's business. Even if it gets more money from the higher revenue per click generated by Google's ad technology, relying on its biggest adversary raises the possibility that a central part of the company's business could be hollowed out.

Evidently Yahoo Chief Executive Jerry Yang has evaluated the possibilities carefully and saw a Google ad deal as a lesser evil to joining forces with Microsoft.

Microsoft CEO Steve Ballmer saw the Google possibility as a poison pill of another kind.

"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search terms offered by Yahoo today," Ballmer wrote in a message to Yahoo CEO Jerry Yang announcing the offer had been withdrawn. "In our view, such an arrangement with the dominant search provider would make an acquisition of Yahoo undesirable to us."

Of course, with Microsoft walking away from Yahoo, Yahoo could walk away from Google. For that strategy to be successful in the long run, Yahoo would have to reverse the steady market share losses to Google in search ads and to strengthen its display-ad business.

And it's not a great market for a turnaround. Yahoo will have to prove its advertising merits during an economic slowdown that so far has left Google unfazed.

All these options, though, must be assessed in light of the company's stock performance on Monday.

Yahoo faces a potentially frosty splash of cold water if Wall Street sends shares down toward $19.18, where they were trading before Microsoft launched its attempt to acquire Yahoo; on Friday, the stock closed at $28.67 after negotiations with Microsoft restarted. Without Microsoft offering a convenient assessment of Yahoo's worth, shareholders will have to reassess Yahoo's ability to build its stock up to that level on its own

A serious decline in value is in effect a major vote of no confidence that could help restart a new Microsoft offer. Chief Executive Jerry Yang, already under pressure, would face even more.

One source familiar with Yahoo's negotiations sees Microsoft's move as an indication that it'll be business as usual again for the companies.

"I'm not surprised" by Microsoft's withdrawal, the source said, declining to speculate about whether it might return later with another offer. "They had their price and we had ours, and now people will just go about their business."

Even if the Microsoft offer really is dead, it seems unlikely Yahoo can turn the clock back to January 31 and hope we'll all forget about that pesky Microsoft distraction. Shareholders, for one, got a taste of Yahoo stock at a much higher level than the search company had been able to reach on its own.

Through its ad partnership test with Google, Yahoo has shown it's willing to take drastic measures to turn its business around. Even without Microsoft around to pump up the stock price, the company has raised expectations for better performance.

CNET News.com's Dawn Kawamoto contributed to this report.