Yahoo Inc shares fell for a second straight day after the company announced a Web search partnership with Microsoft Corp that failed to live up to Wall Street expectations.

Even as the broader market rallied, Yahoo shares dropped as much as 6 percent on Thursday. The stock recovered a little in late trading, but is still down 14 percent since the agreement was announced on Wednesday morning.

The deal, in which Yahoo essentially outsources search to Microsoft, is being viewed by analysts as more positive for the software company than for Yahoo. Microsoft's stock rose about 1 percent on Thursday.

Everybody was anticipating something much more than this, said Bob Bacarella, portfolio manager at the Monetta Fund, which does not own Yahoo shares. To me it's like Yahoo sold their soul, but they still don't have a body.

Some investors had hoped the deal would help pave the way for an acquisition of Yahoo by Microsoft, which offered as much as $33 a share to buy the company last year. Yahoo shares were down 3 percent at $14.65 in Thursday afternoon trading.

Others were disappointed that Microsoft did not agree to pay Yahoo an upfront payment, which some had expected to be several billion dollars.

With the prospect of a Microsoft acquisition no longer on the table, investors are taking a harder look at Yahoo's fundamentals, said Mark Coffelt, a portfolio manager at the Empiric Core Equity Fund.

People are reassessing why they own Yahoo and where it's going to trade and how fast it's going to grow, said Coffelt.

Yahoo currently trades at around 34 times historic earnings, compared with Google Inc's 21 times multiple.

It's priced to see the company grow really rapidly and there's certainly no evidence of that in the last few years, Coffelt said.

Cowen & Co analyst Jim Friedland said the PE ratio does not tell the entire story on account of Yahoo's significant holdings in Asian assets, including the Alibaba Group, which owns Alibaba.com Ltd.

Looking at Yahoo from an enterprise value to EBITDA (earnings before interest, tax, depreciation and amortization) ratio basis, he said the stock has valuation support. But that does not mean it has any upside in the near term.

Just because something trades at a low multiple doesn't meant there's not a good reason for it, said Friedland.

Microsoft Chief Executive Steve Ballmer said on Thursday the deal was not understood in the market.

It's a win-win deal from my perspective, he said, adding he was surprised by the steep fall in Yahoo's shares.

Trading in Yahoo calls options appeared to be adding further, indirect pressure to the stock, said some market watchers.

Before the announcement, there had been a lot of interest in Yahoo call options on hopes that pending news would lift Yahoo shares. However, since that did not happen, there has been aggressive selling to close bullish call positions established prior to the announcement, said Frederic Ruffy, option strategist at Web information site WhatsTrading.com.

(Reporting by Alexei Oreskovic; additional reporting by Doris Frankel; editing by Andre Grenon)

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