In a response late Thursday, Yahoo Chairman Roy Bostock signaled that the Sunnyvale-based company is prepared to battle the New York financier.
Bostock criticized Icahn for having a "significant misunderstanding of the facts" about Microsoft's offer and the Yahoo board's response. He also emphasized that Yahoo remains open to a sale "if it offers our stockholders full and certain value."
To pressure Yahoo, Icahn has nominated an alternate slate of directors to replace the current board in an election scheduled July 3 at Yahoo's annual meeting. If the uprising is successful, an Icahn-led board presumably would fire Yang as CEO and try to negotiate a sale to Microsoft.
In his letter to Bostock, Icahn lambasted the board's actions as "irresponsible" and "unconscionable," given that Yahoo's stock stood at $19.18 before Microsoft first made its bid. He urged the board to reopen the talks.
"I believe that a combination between Microsoft and Yahoo is by far the most sensible path for both companies," Icahn wrote.
Bostock defended Yang and the Yahoo board in his letter to Icahn. "We continue to believe that Yahoo's current board has the independence, the knowledge, and the commitment to navigate the company through the rapidly changing Internet environment and to deliver value for Yahoo and its stockholders," Bostock wrote.
To gain leverage in the looming battle, Icahn revealed that he has spent more than $1 billion snapping up 59 million Yahoo shares and options to give him a 4.3 percent stake in the company. He plans to seek approval from the Federal Trade Commission to acquire up to $2.5 billion in Yahoo stock, including his current holdings.
Icahn's challenge opens a dramatic new chapter in a saga that began Jan. 31 when Microsoft stunned Yahoo with a takeover bid that started out at $44.6 billion, or $31 per share, and then rose to $47.5 billion, or $33 per share, earlier this month.
The showdown now features at least five billionaires with diverse agendas: Yang and fellow Yahoo co-founder David Filo, who believe Yahoo is worth at least $53 billion; Icahn and basketball team owner Mark Cuban, who has agreed to help shake up the company that made him rich; and Microsoft CEO Steve Ballmer, who, until recently at least, viewed Yahoo as a key weapon in his crusade to topple Internet search and advertising leader Google Inc.
Hoping to seal the deal, Ballmer orally offered to buy Yahoo $33 per share. But Yang and Filo - speaking on behalf of Yahoo's board - sought $37 per share, a price the stock hasn't reached in more than two years. The impasse prompted Ballmer to withdraw the bid.
Yahoo shares rose 61 cents, or 2.3 percent, to finish Thursday at $27.75. That's the stock's highest closing price since Microsoft broke off talks.
While Icahn made it clear he wants Yahoo sold to Microsoft, there are no guarantees the software maker is still interested in buying its rival.
A Microsoft spokesman declined to comment on Icahn's letter, saying the Redmond, Wash.-based company has "moved on."
Besides Icahn, the alternate slate of nominees includes Cuban, who sold Broadcast.com to Yahoo for $8.1 billion in stock in 1999. Cuban used part of his Yahoo windfall to buy the Dallas Mavericks, a National Basketball Association franchise that he still owns. He called upon Yahoo to sell to Microsoft in a February blog posting.
If Yahoo can't find a way to placate Icahn, the battle threatens to distract Yahoo and the rest of the company's management from their turnaround efforts, said James Post, a Boston University professor specializing in corporate governance and ethics.
"Senior management cannot concentrate on managing the business when they are concentrating on managing critical relationships with angry shareholders," Post said.
And there's no doubt Yahoo shareholders are furious, said Darren Chervitz, co-portfolio manager of the Jacob Internet Fund, which owns about 100,000 Yahoo shares.
"There's a strong feeling that Yang and the board did not do their fiduciary duty," Chervitz said. "They had a very strong offer on the table and did everything to brush it aside, if not sabotage it."
Paulson & Co., a New York hedge fund that owns 50 million Yahoo shares, said Thursday that it will back Icahn's alternate slate of directors if Yahoo's board doesn't negotiate a sale to Microsoft.
Icahn has a long history of challenging corporate boards overseeing troubled companies. Most recently, he has forced major changes at Blockbuster Inc. and Motorola Inc. He also played a pivotal role in the recent $8.5 billion sale of business software maker BEA Systems Inc. to rival Oracle Corp., which dropped an earlier bid of $6.7 billion.
The billionaire investor's other notable nominees to the Yahoo board include: venture capitalist Adam Dell, whose brother, Michael, founded Dell Inc.; and Frank Biondi Jr., the former chief executive of Viacom Inc.
Icahn also recruited two nominees that Microsoft reportedly lined up for a possible hostile takeover attempt that never materialized. Those two are advertising executive Edward Grey and former Nextel Partners CEO John Chapple.
The revolt threatens to jettison Yang, 39, from the company that he started with Filo, 41, while they were graduate students at Stanford University 14 years ago. Together, Yang and Filo still own 134 million Yahoo shares, or nearly 10 percent of the company.
Yang has argued Yahoo eventually will be worth more than Microsoft's last offer if it can expand its share of a rapidly growing Internet advertising market. He has pledged to boost Yahoo's net revenue growth by 25 percent in 2009 and 2010 - well above the company's recent pace of 12 percent.
"It is irresponsible to hide behind management's more than overly optimistic financial forecasts," Icahn wrote Bostock.
Although Ballmer and other Microsoft executives have been saying publicly they don't need to buy Yahoo to bolster the company's unprofitable Internet operations, many analysts have dismissed the statements as posturing.
Collins Stewart analyst Sandeep Aggarwal believes Microsoft will eventually buy Yahoo for $33 or $34 per share. The "body language from Yahoo and Microsoft do not suggest that both companies have really moved on," Aggarwal wrote in a Thursday research note.
If the two companies really abandoned hope for a deal, Aggarwal reasons they would have already announced other moves indicating they were heading in a new direction.
For instance, Yahoo has been discussing a possible advertising partnership with Google for weeks without agreeing to a deal. And if Microsoft weren't still interested in Yahoo, Aggarwal believes the company would have already announced another acquisition or "radical changes" in its strategy for building a more compelling Internet search engine.
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Associated Press Business Writer Jennifer Malloy in New York
contributed to this story.
