If we have not concluded an agreement within the next three weeks, we will be compelled to take our case directly to your shareholders, including the initiation of a proxy contest to elect an alternative slate of directors for the Yahoo board.”

–Microsoft CEO Steve Ballmer, April 5, 2008

Yahoo (YHOO) let Microsoft’s (MSFT) deadline for a response to its $40 billion-plus offer for the Sunnyvale, Calif., Internet company pass without a word Saturday. And according to people familiar with the situation, the companies haven’t traded words for several days.

So what now? Will Microsoft go hostile, take its case directly to Yahoo’s shareholders and drag the company kicking and screaming into acquisition talks? Will it raise its offer to bring Yahoo to the negotiating table? Or will it sheathe its still rattling saber and walk away, turning its attentions to other “organic and inorganic” strategies, leaving Yahoo to the mercy of a spiteful market undoubtedly livid over the company’s handling of an offer that initially put a 62% premium on Yahoo shares?

The first option’s an unpleasant one for all involved. A messy proxy fight. Employee attrition. Litigation, perhaps. The second option’s perhaps too humbling for Microsoft, which has said over and over again that its offer is a fair one. And the third? Well, you’d think at this point that it’d be pretty satisfying for Microsoft to withdraw its bid and send Yahoo’s shares spiraling off into the murky depths. Aha! Not so “undervalued” now, are we? Mm-hmm. And if Yahoo’s stock were to tank, Microsoft could conceivably double back with a second offer–perhaps even a slightly lower one–that might be a bit more warmly received than its original bid. There’s more than one way to an amicable transaction, yeah?

On a post-earnings conference call this afternoon, Microsoft (MSFT) CFO Chris Liddell said Yahoo (YHOO), which insists Microsoft’s $31-per-share hostile offer “massively undervalues” it, has “unrealistic expectations” about its worth. “Our initial offer was extremely generous, more than a 100% premium for Yahoo’s core business, and our view on value is shaped by the long-term value of the company, and we intend to remain disciplined in our approach,” Liddell said. “The strongest argument that I’ve heard on why we should increase our bid–simply that we can afford to–is not one that I favor. We’ve yet to see tangible evidence that our bid substantially undervalues the company. In fact, we see the opposite. Yahoo continues to lose search share, and profitablity continues to decline year-on-year.”

It sure does. Yahoo’s operating income for the first quarter of 2008 was $121 million–a 28% decrease compared to $169 million for the same period of 2007. But then, Microsoft doesn’t want Yahoo for its profits; it wants it to make its own advertising platform more successful. Is that worth more than $31-per-share? Liddell clearly doesn’t seem to think so. “Unless we make progress with Yahoo toward an agreement by this weekend, we will reconsider our alternatives,” he said. “We will provide updates as appropriate next week. These alternatives clearly include taking an offer to Yahoo shareholders or to withdraw our proposal and focus on other opportunities, both organic and inorganic.”

Even after the relatively weak first-quarter showing Yahoo made yesterday, the Web’s perennial underachiever continues to claim Microsoft’s $31-per-share hostile offer “massively undervalues” it. And perhaps it does, just a wee bit. But then Yahoo’s shares were trading at just over $19 the day before Microsoft announced its bid for the company. Today they’re at $28.14.

And while Yahoo (YHOO) may have forgotten that, Microsoft (MSFT) certainly hasn’t. With the three-week deadline for Yahoo to accept its offer set to expire Saturday, Microsoft again called for Yahoo to come to the bargaining table. “We know what Yahoo’s worth,” CEO Ballmer said today at a Microsoft conference in Milan. “$44 billion is a lot of money. If Yahoo’s shareholders like it, that’s great. We are prepared to go forward without a merger with Yahoo. … Time is money, we’ve made that clear.”

Note that Ballmer doesn’t explicitly say Microsoft won’t raise its offer. But by suggesting the company is prepared to scrap the deal, he’s implicitly threatening to gut Yahoo’s stock price.

And with Circuit City (CC) refusing to allow the video-rental company access to its books until Blockbuster proves it can actually afford the acquisition, it would seem hostile is the only way to go. “The heart of the matter is that we still need further facts,” Keyes told The Wall Street Journal, referring to Blockbuster’s failure to gain access to Circuit City’s books. “With those facts, we can choose whether to proceed or get back to our continued success.”