Blame it on Google

(Fortune) -- Google proved to be the final straw that broke Microsoft CEO Steve Ballmer's back.

After weeks of threatening Yahoo (YHOO, Fortune 500) that the software giant would attempt a hostile takeover if the company refused its bid, Ballmer explained Saturday why he decided to withdraw his offer for the Internet portal. He was walking away because of his archrival Google.

Yahoo would become "undesirable" if it formed an alliance with Google, Ballmer said in a statement. Last month, Yahoo had outsourced some of its search advertising results to Google (GOOG, Fortune 500) in a two-week trial. The Internet portal said it was considering a long-term partnership with Google and that a deal could be announced as early as next week, a source familiar with the matter said.

Yahoo did not specify if it would continue to pursue the plans with Time Warner (TWX, Fortune 500) or Google that it had pursued in the last three months. Said Yahoo CEO Jerry Yang: "With the distraction of Microsoft's unsolicited proposal now behind us, we will be able to focus all of our energies on executing the most important transition in our history so that we can maximize our potential to the benefit of our shareholders, employees, partners and users."

In a letter to Yang, Ballmer gave five reasons why he decided to quit pursuing a bid. First, a Google-Yahoo tieup would encourage advertisers to use Google as opposed to Panama, Yahoo's own search system. Not only would that fragment Yahoo's search advertising strategies, it would also "undermine the reliance on your display advertising business to fuel future growth," Ballmer wrote.

Ballmer said there were a host of other problems. Yahoo would suffer an engineering brain drain. There would also be regulatory issues that Microsoft would not be willing to "inherit." Microsoft (MSFT, Fortune 500) has argued that a Yahoo-Google deal would give the two a 90% dominance in search advertising, and make an acquisition difficult to pass through regulators.

Finally, a Google-Yahoo partnership would make Google even more dominant and force other search providers to rely on Google. Microsoft worries that a deal with Google not only would reduce competition, it could possibly force others to switch to using Google as well. Microsoft has repeatedly argued that it cannot catch up to Google and compete in the online ad market without merging with the second-largest player, Yahoo.

Microsoft's decision came after its board debated for a week whether to raise its bid, go hostile or walk away. Yahoo and Microsoft had been in talks to negotiate a price but were unable to reach a friendly deal.

Microsoft raised its original cash-and-stock offer from $31 a share to $33, an increase of $5 billion, but Ballmer said Yang wanted more. "It has proven insufficient," Ballmer wrote in a letter to Yang on Saturday. "Your final position insisted on Microsoft paying yet another $5 billion or more."