Microsoft pulls its Yahoo offer

Update 5 p.m. PDT: Microsoft has made its move official. Click here for the story and here for the text of a letter Ballmer sent to Yang.

Microsoft is withdrawing its offer for Yahoo after talks between the two companies broke down on Saturday, a source told CNET News.com.

Microsoft hiked its offer to $33 a share, but Yahoo was holding out for $37 a share, the source said. The two sides met face to face again Saturday, but remained far apart.

Although price was a key issue, Microsoft also had strategic concerns and saw it as unlikely to achieve a friendly integration process. According to a source close to Microsoft, Yahoo founder and CEO Jerry Yang had "unrealistic expectations."

Microsoft made its $31 a share cash and stock offer on February 1. Yahoo rejected the bid as undervaluing the company, and the two sides had only the most basic of negotiations until Microsoft set a three-week deadline last month. Negotiations heated up on Friday, but the two sides remained far apart.

The move leaves both companies in a tenuous spot. Although Microsoft has said it has a strategy to take on Google without Yahoo, Yahoo represented the biggest opportunity for Microsoft to gain scale against its rival, which has a much larger Internet advertising business.

Yahoo, meanwhile, has had talks with AOL and Google, but it is unclear whether deals with either would produce the kind of immediate return for shareholders that a Microsoft deal would offer.

Microsoft is expected to announce its move publicly shortly, according to the source.