Legg Mason (LM) is reeling. The Baltimore-based asset manager swung to a first-quarter loss of $256 million, or $1.81 a share, from the year-ago profit of $173 million, or $1.19 a share. The latest quarter was hit by $206 million in charges tied to the company’s decision to support money-market funds that suffered losses after they invested in illiquid structured debt, and a $95 million hit in a wealth management unit. Revenue fell 6% from a year ago to $1.07 billion. Analysts were looking for a 27-cent loss on revenue of $1.12 billion.

“This past quarter was among the most difficult we have ever faced and we are disappointed with our results,” said CEO Mark Fetting. “We remain a fundamentally strong firm today, but we know we have work to do.”

Indeed, assets under management fell 5% from a year ago to $950 billion, as the company’s portfolio suffered market losses of $28 billion and customer cash outflows of $19 billion.  Equity outflows were $17 billion and fixed income outflows were $7 billion for the quarter, while liquidity inflows totaled $5 billion.

“We have major managers who are performing very well in a tough investment climate, and we are seeing growth outside the U.S.,” Fetting said, “but we know that we need our U.S. equity managers to return to form, and this is a top priority.”

Among the managers who need to return to form is Legg Mason Value Trust manager Bill Miller, whose fund lost 20% of its value in the first quarter after bad bets on struggling financial firms such as Bear Stearns (BSC) and Countrywide (CFC). The losses haven’t curbed Miller’s appetite for publicity, however. A day after he called on Yahoo (YHOO) to buy back stock, he told Bloomberg in an interview that he expects Microsoft (MSFT) to come back to the table with a new offer for the Internet giant - though perhaps not for a while. “If I’m sitting in their shoes, I’ll go away and see what happens,” Miller said of Microsoft. “I can come back and the worst case is, I’ll pay six months more of my free cash flow.” 

Monday’s selloff in Yahoo (YHOO) is creating more pain for value manager Bill Miller. Miller is chief investment officer at Legg Mason Capital Management, which at Dec. 31 was Yahoo’s second-biggest shareholder, with a 6.9% stake, according to Lionshares.com. Yahoo had been one of the standout performers in Miller’s Legg Mason Value Trust, which lost 20% of its value in the first quarter as big bets on beaten-down financial stocks such as Bear Stearns (BSC) went sour. But Monday’s 14% decline in Yahoo takes the stock about half the way back to where it was trading before Microsoft (MSFT) unveiled its $31-a-share bid on Feb. 1. Should they stick, Monday’s declines will reduce the fund’s gains in Yahoo accordingly.

Miller indicates in an interview with The New York Times that he’s surprised by Microsoft’s decision to walk away from Yahoo, and eager to see Yahoo do something to justify shareholders’ patience. He wants to see CEO Jerry Yang turn some of Yahoo’s cash holdings toward a share buyback, he says in the interview. “It would be almost incoherent not to do so,” Miller said. “You can’t maintain that $33 undervalues your company, have your stock trade below that, and not buy back stock.”

Despite the Yahoo selloff and Monday’s decline in another big Legg Mason holding, Countrywide (CFC), Miller’s doing better in the second quarter. He noted two weeks ago in his first-quarter letter to Value Trust shareholders that the fund was ahead of the S&P, and a look at Legg Mason’s biggest holdings as of March 31 shows that only two of his top 10 stocks - UnitedHealth (UNH) and General Electric (GE) - are down this quarter. “I think we will do better from here on,” Miller wrote on April 23, “and that by far the worst is behind us.” So far, so good.

Yahoo (YHOO) shareholders aren’t happy. Shares of the Internet search giant dropped 21% in Frankfurt as trading resumed following the company’s decision to reject a sweetened $33-a-share buyout proposal from Microsoft (MSFT). Yahoo said it wanted $37 a share, a demand that Microsoft chief Steve Ballmer dismissed as too rich. The decision will put Yahoo CEO Jerry Yang under renewed scrutiny, and raises the question of what Microsoft will do next as well. But for now, Microsoft shares are up 4% overseas - meaning Ballmer, at least, isn’t under pressure this very moment.

Yahoo (YHOO) and Microsoft (MSFT) are going their separate ways. Microsoft withdrew its proposal to acquire Yahoo Saturday, after the sides failed to reach an agreement on price. Microsoft, which surprised Yahoo three months ago by going public with an unsolicited cash-and-stock bid worth $31 a share, raised the ante to $33 this weekend but then folded after Yahoo demanded $37. Many observers had expected a deal to get done around $35 a share, so Yahoo’s insistence on a higher figure will raise some eyebrows in coming days.

Microsoft chief Steve Ballmer questioned Yahoo’s decision to demand more money, noting that Microsoft’s revised proposal would have given Yahoo shareholders a 70% premium to their shares’ trading price as of Jan. 31, the day before Microsoft floored tech watchers by unveiling its $44.6 billion bid. “I still believe even today that our offer remains the only alternative put forward that provides your stockholders full and fair value for their shares,” Ballmer wrote in a letter to Yahoo CEO Jerry Yang. “By failing to reach an agreement with us, you and your stockholders have left significant value on the table.”

Ballmer also criticized Yahoo’s decision to consider outsourcing some of its search business to rival Google (GOOG), and suggested that only this week did he appreciate the lengths Yahoo would travel to avoid a Microsoft deal. “I feel that our discussions this week have been particularly useful, providing me for the first time with real clarity on what is and is not possible,” Ballmer said. “After giving this week’s conversations further thought, it is clear to me that it is not sensible for Microsoft to take our offer directly to your shareholders.”

By walking away, Microsoft will put pressure on Yahoo to show its shareholders why they should stick around to watch Yahoo struggle to keep pace with Google. While Yahoo says it remains “steadfast in our belief that Microsoft’s offer undervalued the company, and we are pleased that so many of our shareholders joined us in expressing that view,” the question now is how understanding Yahoo shareholders will be on Monday, when the company’s stock opens for trading without the Microsoft proposal off the table.

Yahoo’s (YHOO) hand looks a lot stronger today than it did just a few days ago. The Internet company is in discussions with Time Warner (TWX), publisher of Fortune, for a deal that would give Yahoo control of AOL and Time Warner a stake in Yahoo, according to The Wall Street Journal.

Under the possible Yahoo-AOL deal, Time Warner would put some cash into Yahoo and get a 20% stake in the combined Yahoo-AOL. Yahoo would then buy back billions of dollars in stock in a bid to support its share price, which is likely to fall if Microsoft’s $31-a-share bid is pulled. The deal comes just a day after Yahoo unveiled a deal to test out a combination of its search ad business with Google’s (GOOG).  

But Microsoft (MSFT), which has been pursuing Yahoo for more than two months, isn’t standing still either: The New York Times reports it is talking with Myspace owner News Corp. (NWS) about a joint bid for Yahoo. Some investors expect the AOL talks to only strengthen Microsoft’s resolve to complete the deal - and to lead to the higher price Yahoo chief Jerry Yang has been demanding.

“Yahoo is a strategic necessity for Microsoft,” Gamco Investors portfolio manager Larry Haverty told Bloomberg television. “Microsoft cannot allow this deal to happen,” he added, referring to a possible AOL-Yahoo tie-up. He expects Microsoft to raise its bid and says he believes a fair value for Yahoo to Microsoft is $35 a share. The AOL talks, he concludes, have “raised the floor” on Yahoo stock. Yahoo shares rose modestly in early trading Thursday, rising 42 cents to $28.19.

Yahoo (YHOO) shares fell 6% in after-market trading Friday after Reuters reported Microsoft (MSFT) is “evaluating” its $42 billion offer for the Internet company. The news agency cited a person familiar with the matter.

The comments, which suggest Microsoft is considering walking away should Yahoo fail to agree to terms, come on the heels of reports that executives at the two tech titans met this week but failed to reach an agreement on the cash-and-stock offer. Microsoft’s worried that a slowing economy and changes in Yahoo’s business stand to lower its value, Reuters reports.

Yahoo’s top brass is to meet Monday to discuss the situation, CNBC reports. It seems unlikely that either side would let the deal collapse at this point, given Microsoft’s strategic challenges in competing with Google (GOOG) and the apparent failure of Yahoo to attract any rival bidders. But Friday’s late action shows that Yahoo shareholders, who have seen the value of their investment jump 48% since Microsoft unveiled its offer on Feb. 1, are starting to get nervous.

Yahoo (YHOO) is playing for time. The company amended its bylaws to extend the deadline for nominating directors to its board from next week to some undetermined date in the future. The move comes just weeks after Yahoo rejected a $41 billion unsolicited bid from Microsoft (MSFT), calling it inadequate. Microsoft has responded by preparing a proxy fight in which it would seek to seat its own board.

Earlier, The New York Times reported that Yahoo was considering extending the board-nomination deadline in a bid to avoid capitulating to Microsoft. But that’s not how Yahoo sees it. The new deadline falls a week after the company’s annual meeting, whose date has yet to be set - giving Yahoo more time to seek alternatives, as they say, to maximize shareholder value. Everyone, the company adds, should be happy with this arrangement.

“As the company has not yet announced the date of this year’s annual meeting,” Yahoo said, “the amendment will give stockholders who want to nominate one or more directors, including Microsoft Corporation, more time to do so.” Microsoft will surely be grateful for the gesture.

Yahoo (YHOO) shares rose 2% in pre-market trading after the Internet company did as Wall Street expected and rejected Microsoft’s (MSFT) takeover offer. Sunnyvale, Calif.-based Yahoo said the deal, recently valued at just over $29 a share in cash and stock, isn’t in the interest of shareholders. “After careful evaluation, the board believes that Microsoft’s proposal substantially undervalues Yahoo! including our global brand, large worldwide audience, significant recent investments in advertising platforms and future growth prospects, free cash flow and earnings potential, as well as our substantial unconsolidated investments,” Yahoo writes. “The board of directors is continually evaluating all of its strategic options in the context of the rapidly evolving industry environment and we remain committed to pursuing initiatives that maximize value for all stockholders.” The question now is what alternatives, if any, remain open to Yahoo, and what Microsoft will do. For the moment, with Yahoo shares approaching $30 - up from $19 and change before Microsoft made its merger proposal public back on Feb. 1 - the betting in the stock market is on a higher offer from Microsoft.

Yahoo (YHOO) tells employees not to be distracted by the hubbub around Microsoft’s (MSFT) unsolicited $44.6 billion bid. Top execs told Yahoos Friday that the company is considering various options, according to a filing made Monday morning with the Securities and Exchange Commission. “Microsoft’s proposal is one of many options that we’re evaluating in order to maximize value for our shareholders and employees over the long-term,” Yahoo chief Jerry Yang and nonexecutive chairman Roy Bostock wrote Friday in an email to employees. “That’s why we will respond to Microsoft after our board has completed a careful review of all of our strategic alternatives.”

It remains unclear what Yahoo’s other options might be, given the huge premium to recent trading prices that Microsoft’s proposal offers beleaguered Yahoo shareholders. But Google is doing what it can to muddy the picture. CEO Eric Schmidt called Yang offering to help Yahoo stay independent, The Wall Street Journal reports. This after a weekend in which a top Google exec accused Microsoft of repeatedly seeking to establish “proprietary monopolies” - as if Google has been known for playing nice in the marketplace.