NEW YORK (Reuters) - Yahoo Inc on Monday rejected as too low Microsoft Corp's unsolicited takeover offer, currently valued at $42 billion, putting the ball back in the software giant's court to pursue a deal.

In a statement, Yahoo said its board unanimously concluded the proposal was not in the best interests of its shareholders.

The company said the offer "substantially undervalues" its "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 added that its board was evaluating all its strategic options.

Microsoft made the half-stock, half-cash offer on February 1. It was originally worth $44.6 billion, or $31 per share -- a 62 percent premium to Yahoo's stock price. Since then, Microsoft shares have fallen, and the deal is now worth $41.5 billion.

Microsoft now must decide whether to sweeten its offer, launch a proxy fight or simply withdraw.

"We think that Microsoft will likely increase its offer to $35/share and may go as high as $40," Sanford C. Bernstein said in a research note to clients on Monday.

While the firm's top Internet, media and technology analysts said they believed a negotiated settlement was likely, there was still a chance that "the Yahoo board is digging in for a fight ... and the situation will turn ugly."

Yahoo shares were up 2.1 percent at $29.81 in early Nasdaq trade.

If completed, a merger of Microsoft and Yahoo would be the world's largest of two computer technology companies and would create a formidable rival to Internet search and advertising leader Google Inc.

(Reporting by Megan Davies and Michele Gershberg; editing by Lisa Von Ahn and John Wallace)

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