Shares in internet search company Yahoo (YHOO) dropped 10% yesterday as the prospect of a deal with Microsoft ended.

According to Bloomberg: “Yahoo said yesterday it scrapped talks after Microsoft refused to pay the $47.5 billion it offered last month. Instead Yang unveiled a partnership with Google Inc. While that deal may add $800 million to annual sales, it may not be enough to revive the stock, said analyst Colin Gillis of Canaccord Adams.”

“Microsoft originally offered $31 per share in either cash or Microsoft stock, a 62% premium to Yahoo’s Feb. 3 closing price. It boosted the bid to $33 a share, appraising Yahoo at approximately $47.5 billion, but Yahoo refused to accept anything less than $37,” says Jason Simpkins of Money Morning

[In April] Yahoo reported a first-quarter profit of $542 million, or 37 cents per share, up from $142 million, or 10 cents per share last year. It was the company’s first profit increase in nine straight quarters (more than two years).

But a big reason for the jump was a one-time gain of $401 million - a windfall from the sale of Yahoo’s stake in Alibaba.com Ltd.’s (PINK:ALBCF), which came from the Asian Internet company’s initial public offering (IPO).

Excluding one-time items, Yahoo reported earnings of 11 cents a share.

Even with the profit increase, the company continued to lose market share to nemesis Google Inc. (GOOG), the leader in Internet search. Yahoo accounts for 21.3 % of all U.S. searches according to comScore Inc.

That compares with a near 60% sway for its rival, Google, which defied Wall Street’s first-quarter expectations by expanding its revenue nearly four times faster than Yahoo. While Yahoo’s sales climbed 14% last quarter, Google posted a 46% jump in revenue. In April, Yahoo all but acknowledged Google’s victory by outsourcing a small portion of its search advertising to its competitor on a two-week trial basis.

If Yahoo continues using Google’s search advertising system, it will be abandoning its own “Panama” ad system. Launched in February, the Panama initiative set the company back millions of dollars. Even so, it continues to lag behind Google’s AdSense in terms of revenue per search query.

As it worked to bulk up its search capabilities, Yahoo had earlier shelled out $1.63 billion for Overture Services and $235 million for Inktomi. That’s close to $2 billion for search engine service specialists that would for, all intents and purposes, be rendered moot should Yahoo ultimately outsource even more of its search-related business.

While some analysts believe a bigger deal with Google may already be in the works, any serious collaboration between the United States’ two largest web portals would very likely run afoul of U.S. antitrust restrictions.

Google already places ads on more than 67% of searches. The addition of Yahoo would expand its influence to 89% of searches, according to statistics from Hitwise. Microsoft said last month that Google would command more than 90% of the search advertising market.

“While Yahoo may pursue a Google search partnership as a way to appease shareholders through enhanced cash flow, we believe such a deal would face intense anti-trust scrutiny,” Clayton Moran, an analyst with Stanford Group Company, told IDG News Service. “In addition it would cede control of search to Google.”

Moran does not believe Yahoo’s stock will reach the $37 a share value over the next 12 to 18 months.

There have also been rumors that Yahoo will join forces with Time Warner Inc.’s (TWX) AOL or News Corp.’s (NWS) Fox Interactive Media business units. According to the details that have emerged so far, Time Warner would merge a large portion of AOL’s operations with Yahoo and make a cash investment in exchange for a 20% stake in the resulting company. Yahoo would use that cash infusion to buy back some of its own stock.

However, when it comes to Web-search market share, AOL currently ranks fourth, behind Google, Yahoo and Microsoft. So the company that emerged from that combination would be more of a content player than it would be a competitive Web-search firm.

“I’m looking for Microsoft to get aggressive with a buying spree,” Gartner analyst Allen Weiner told IDG. “I think Microsoft should do something quickly to show the world that [the] Yahoo bid wasn’t a setback.”

The company could try to strike a deal of its own with Time Warner or News Corp., or perhaps even with the trendy Facebook.com. Other analysts suspect Microsoft may be beckoned back to Yahoo’s rescue if the company fails to right its course by year’s end.

“Should Yahoo miss expectations in 2008, we would not be surprised to see MSFT come back to the table,” said RBC Captial analyst Ross Sandler.