Precisely six words in Google’s news release Thursday afternoon tell the whole story: “despite a more challenging economic environment.” The words are attributed to Google (GOOG) CEO Eric Schmidt, and they explain why the stock is plummeting in after-hours trading. Google shares were down 12% at last check. That’s $62 per share. Yes, Google’s missed Wall Street’s earnings expectations. But the real thing to focus on in the earnings call, beginning at 4:30 Eastern, is what Google has to say about the economy. Until now, as I’ve written, Google hasn’t been touched.

But the weak economy clearly is affecting online advertising companies. Valueclick’s (VCLK) pre-announcement knocked 20% off its stock Thursday. This can’t be good for Yahoo (YHOO), though those shares haven’t budged much so far.

That, ostensibly, is the theme of this November’s Web 2.0 Summit, the excellent conference in San Francisco run by John Battelle and Tim O’Reilly. Actually, the theme is “sustaining, expanding and applying the Web’s lessons,” and I have a hunch John and Tim are treading on dangerous ground by overbroadening their mission. The conference, which has become the event for mainstream Net-focused business types, this year will include “leaders in the fields of healthcare, genetics, finance, global business, and yes, even politics,” according to its Web site.

But I digress from the more important business at hand, namely the outstanding dinner the duo threw Wednesday night at the Foreign Cinema restaurant in San Francisco’s Mission District. They took over the entire restaurant — people in the food biz call that a “buyout” — which is impressive given that the very Web 2.0 company Slide hosted a party the same evening at other end of town. I’m guessing that the crowd at Slide’s party was younger and slightly less male, but again, I digress.

So what is next for the Web? Judging from my conversations, two topics are front of mind: Apple’s (AAPL) iPhone platform and resolution of the Yahoo (YHOO)-Microsoft (MSFT) debacle. The former has got the tech crowd excited; the latter has it depressed and wishing the drama would end.

In terms of who’s doing what, here are a few people I bumped into. Ellen Siminoff has become a half-marathoner. Go Ellen. Former Ask boss Jim Lanzone is looking really relaxed after three years at IAC/Interactive (IAIC). (Jim has been dabbling in VC-dom at Redpoint Ventures, among other things.) I bumped in Ram Shriram, an early investor in Google, who told me he’d read my feature on Kleiner Perkins in the current issue of Fortune. That reminded me of something I’d left out of the story, namely how starkly Kleiner’s China strategy contrasts with its approach to India. Basically, Shriram is Kleiner’s India strategy. It has done seven deals there with him, one of which, Naukri.com, already is public.

I saw Twitter’s Evan Williams but didn’t get to say hello. That company certainly seems to be hitting an inflection point, no? (I’ve been experimenting with Twitter, primarily as a distribution tool for my posts and articles. Follow me, please.)

I also bumped into Google engineering brainiac Matt Cutts, who is unusually interested and conversant in business for a guy whose specialty is fighting spam and other in-the-weeds tech stuff. There were Googlers galore. I had dinner with Bradley Horowitz and Irene Au, both Yahoo refugees. Both seemed really happy to know how much I love PIcasa (I do) and kind of horrified to find out I’ve been having bad experiences recently with Google Maps (I have). Googleconomist Hal Varian was there too. He told me he’ll be on Thursday’s earnings call, which is interesting. He sat with VC (and backcountry hiker) Ann Winblad, whose firm invested in Omniture, which got me thinking … Why doesn’t Omniture make a business out of providing third-party audience-measurement data to the public instead of leaving it to Google to stick it to comScore? Ann thought that was a good question and suggested I ask Omniture CEO Joshua James. Joshua?

Let’s see, there were so many others. I met Brad Burnham of Union Square Ventures, which shows that the little VC shop in New York has the world covered as Brad’s partner Fred Wilson presently is busy hoovering up knowledge about Europe. Brad and I dined with former top Yahoo executive Jeff Weiner, *executive*-in-residence at two VC firms, Greylock and Accel. (That’s right: unique title and unique arrangement.) Jeff’s going to be at the Fortune Brainstorm conference next week in Half Moon Bay. We at Fortune sure are looking forward to seeing him. My buddy Mark Pincus was doing his thing at dinner. I shook hands with his pal Bing Gordon, one of the newest partners at Kleiner Perkins (oh, and a co-founder of Electronic Arts (ERTS)).

Just before leaving, I talked big picture with Reid Hoffman, one of the most engaging big-picture thinkers in Silicon Valley. (He founded LinkedIn, helped start PayPal and is one of the most important angel investors around.)  Reid was at Allen & Co.’s gabfest last week in Sun Valley, Idaho, and he told me he spent a lot of time discussing the relative decline of the U.S. I told him I thought we’d get through this rough patch just fine because for all our faults we’re still the United States. He said that’s exactly what Warren Buffett said in Sun Valley, but that he, Reid, isn’t so sure. That, in turn, made me kind of nervous. So I decided to go home.

I reported in my recent feature on Kleiner Perkins that Miasole, a solar-panel company in Silicon Valley, was in the process of raising around $200 million at a valuation in the neighborhood of $1 billion. That turned out to be a conservative estimate. I’ve since heard authoritatively (though not from KP or Miasole) that the company completed its financing for about $250 million at a pre-money valuation (that means not counting the new cash) of $1.2 billion. To spell this out slowly and carefully, this means that Miasole, which has yet to start selling its product, is worth $1.2 billion before its cash injection. This is Miasole’s fifth round of financing, and its investors surely hope it’ll be the last before its IPO.

As I said, Miasole hasn’t commented on its funding yet, but one of its investors has. The steel company ArcelorMittal announced it has launched a clean technology fund and that its first investment is a $20-million stake in Miasole. Steel companies are massive polluters, of course, and ArcelorMittal operates globally. Promoting cleaner sources of electricity surely is in its interests.

What’s more interesting is if ArcelorMittal will ever make any money on its investment. Despite being pre-revenue, Miasole will already by in IPO mode with its banker, Morgan Stanley (MS), pushing valuations that are comparable to the relatively few solar-panel success stories in the market, like First Solar (FSLR) and SunPower (SPWR). Should Miasole succeed in going public in 2009 or 2010, the only big winners will be Kleiner Perkins and other early investors - unless the public valuation is significantly above a billion dollars.

Venture capital is about many things. They include stock promotion. VCs go to conferences, evangelize, meet with bankers, recruit employees with dreams of stock options and promote, promote, promote until the IPO can pay out for their investors. The IPO game may be off right now, but it won’t stay that way.

I’ll update the VC game as it progresses. It’ll be fun.

Having staked out some ground on the insanity of the mortgage market and regulatory attempts to fix it, I’ve been reading the coverage about Fannie (FNM) and Freddie (FRE) with great interest. Yes, I’ve been spending most of my time writing about the tech biz, especially the Great Google (GOOG) and the Prestigious Kleiner Perkins. But the economy factors into the tech story. And besides, this drama is tough to beat.

Anyway, one theme I keep coming back to in my discussions about this mess is what a disservice we the people did to the we the people by making folks feel guilty for not owning a home. In explaining how many opportunities legislators and regulators had to get it right on Fannie and Freddie, my former Fortune colleague Julie Creswell nailed what I’ve been trying to express in this page one article (go Julie!) in The New York Times over the weekend:

Even after accounting scandals arose at the two companies a few years ago, attempts to push through stronger oversight were stymied because few politicians, particularly Democrats, wanted to be perceived as hindering the American dream of homeownership for the masses.

That’s pitch perfect. Politicians were so enamored with the positives of the American dream — and there are many — that they didn’t have the guts or the intelligence to realize that as a society we’ve been encouraging people who can’t afford the dream to pursue it anyway.

Yes, I own my home. I love that. I like being able to drill holes in the walls, plant perennials in the garden and buy furniture that fits my space. I also hope like hell the property is worth more than I paid for it when it comes time to sell. (And importantly, I can afford my mortgage. I’m grateful for that, but it’s also not an accident.) But I’ve never confused my home with my investment portfolio, and I’ve always known that renting might have made just as much economic sense, depending on my situation.

Think about it. Politicians didn’t want, in Julie’s words, to be perceived as hindering the dream of home ownership. Funny that. By their actions, they’ve hindered the dream far more than had they exercised their oversight responsibilities in the first place.

Is it just me, or is the most interesting and amusing bit of the most recent Yahoo-Microsoft news that Yahoo (YHOO) remains willing to sell to Microsoft (MSFT) for $33 per share?

A short review of the facts. Some time while Terry Semel still was CEO of Yahoo, Microsoft offered to buy the company in the neighborhood of $40 per share.  Yahoo said no. In January, when Yahoo’s shares had sunk to around $19 on continued poor performance and a lack of belief by investors that its turnaround plan will work, Microsoft offered to pay $31 a share. Microsoft’s own investors thought so little of the prospects for success of that bid that they hammered Microsoft’s stock, bringing down the value of the offer for Yahoo to the neighborhood of $29. Yahoo’s response? We think the company is worth $37 per share, and we’re not interested in selling for less.

Since then, there’ve been more twists and turns in this story than a daytime soap. Yahoo indicated it would accept $33 but Microsoft didn’t trust the sincerity of management. Yahoo ran to Google (GOOG) for a deal that would partially outsource search advertising to Google and add cash to Yahoo’s coffers. But that arrangement is neither a total sale of its search operation to Microsoft nor a total money-saving outsourcing to Google. In the meantime, Microsoft offered a search purchase as well as an investment in Yahoo at a $35-per-share valuation. Yahoo rejected that.

That leaves us today, with Yahoo saying it would sell for $33, a 6% increase over Microsoft’s initial offer. That’s a price it easily could have gotten in February but one that Microsoft doesn’t appear willing to pay today.

Today’s Yahoo’s shares trade for less than $23.

A second founding partner of Kleiner Perkins Caufield & Byers’ year-old China Fund has left, this time to work for a competing fund sponsored by a U.S.-based venture firm, Matrix Partners. David Su’s exit follows the departure last year of Joe Zhou, who simply quit after only a few months at Kleiner.

This is getting more than a little embarrassing for the storied Silicon Valley VC firm. In April 2007, Kleiner established its first dedicated fund outside the United States, the $360-million China Fund, run by its newly recruited KPCB China team, dubbed “China Perkins” by Kleiner watchers with a sense of humor.

Kleiner invested about two years trying to figure out the best way to set up shop in China. In my numerous interviews for the Kleiner Perkins feature article in the current issue of Fortune, Kleiner partners told me how carefully they deliberated before choosing the best people to carry their name in China. The goal, said partner Ellen Pao, was “finding a team that would be on the ground that would fit our culture versus trying to get a quick fix, which had been the norm in China.” Other partners involved in the China mission included John Doerr (who opined about the importance of China on the “Charlie Rose Show”), recruiting specialist Juliet Flint, Matt Murphy, John Denniston and Ted Schlein, who currently oversees the project, along with Pao.

It seems Kleiner didn’t choose at all well. It recruited a team run by Tina Ju, who had been at a firm called TDF Capital, and Joe Zhou, who was with the Softbank Asia Infrastructure Fund. According to two sources who know Ju and Zhou, Kleiner wanted Zhou as part of the team because he has more early-stage investing experience than Ju and her team. Zhou, however, didn’t play particularly nice with others - a hallmark of Kleiner’s image - and he decided later last year to strike out on his own. He is attempting to raise a new fund. In an e-mail last week he told me: “Per my agreement with KP, I can’t comment at this point.”

Now an original member of Ju’s team, David Su, has left as well. China Perkins recently airbrushed his name from its Web site.  And Bo Shao, managing partner of Matrix Partners China, confirms by email that Su has signed on with his group.

Kleiner Perkins did not respond to a request for comment on Su’s departure.

This non-U.S. fund business is a tough one for American venture capital firms. They say the funds are extensions of themselves. But in reality they are brand extensions whereby the Sand Hill Road firm charges a “tax” that is the difference between what a top-tier firm like Kleiner collects in fees from its investors and what a less experienced investment team abroad could get. Few are willing to take the one step required to ensure at least that the China entity is infused with the culture of the firm back home: sending a successful U.S. partner to live full time in China.

When I asked John Doerr last week to comment on what was wrong in China, he declined, other than to say he wished Joe Zhou still worked for KPCB China.

VMware (VMW) announced this morning that its co-founder and CEO, Diane Greene, is leaving the company, “effective immediately.” Her replacement is Microsoft (MSFT) retiree Paul Maritz. At the same time, the company lowered its financial expectations for this year in the last line of its news release: “While VMware is not updating guidance for Q2, we expect revenues for the full year of 2008 will be modestly below the previous guidance of 50% growth over 2007.”

Predictably, VMware’s stock is being hammered on Tuesday, down $13, or 25%, to $40 an hour after the announcement. As relevant is the decline in EMC (EMC), VMware’s majority owner, whose shares are down about 9%, or below $14, a new 52-week low. (Maritz recently has been an executive at EMC, which bought a company he started.)

The most successful Silicon Valley IPO since Google, the VMware story has been fascinating to watch, kind of like the old ABC Sports “thrill of victory/agony of defeat.” At its height, VMware — which popularized software that “virtualizes” multiple computers — was so loved by investors that it singlehandedly drove the valuation of EMC, whose best move this decade may have been buying VMware before it had the opportunity to go public the first time. As Microsoft has stepped up its competition with VMware, however, the company’s growth projections have slowed. It’s still a scorcher in terms of growth, but expectations ran away from reality, and the stock drop is the result.

I wrote a feature about VMware’s CEO Diane Greene last year in which I wrote about her friction with EMC. It was a wrought situation. EMC controlled VMware, but VMware was the golden goose, giving Greene a great deal of power. Until, it seems, she couldn’t deliver. The executive quoted in VMware’s release noting Greene’s departure is VMware’s chairman, Joe Tucci, also EMC’s chief executive.

Sometimes one well-crafted line enables a single article to tell an entire company’s story. I found that line over the long weekend in a nicely written piece by New York Times tech writer Brad Stone. Commenting on the breakneck expansion Starbucks followed before it slammed into a no-growth wall, Stone writes:

The company has long been known in the world of commercial real estate for its expertise at selecting prime locations and its fearlessness in establishing almost comic ubiquity in some neighborhoods. Starbucks would not comment for this article. But it appears that the company strayed from the exacting real estate science that it had perfected and guided it through its first expansion wave.

I loved that expression, “almost comic ubiquity,” because I’ve long wondered how in the world Starbucks (SBUX) could thrive in a world where you could see multiple Starbucks outlets without moving. Here’s a cartoon that tells the story nicely as well.

Tech Crunch landed a nifty scoop Saturday, publishing the name of a wealth-management advisor who purportedly is trying to sell shares of Facebook belonging either to an early investor or early employee. This is a peak inside the murky netherworld of investing in startups whereby shareholders in a private company can sell their shares under certain circumstances directly to other investors.

What’s particularly juicy about the revelation is that the investors are shopping a valuation significantly below the infamous $15-billion point Microsoft established when it invested in Facebook last year (the valuation at which a company raises money becomes the de facto valuation). Tech Crunch is reporting that Facebook’s valuation may have fallen as low as $3 billion, at least according to those doing the selling.

The amount an individual is willing to accept in order to dump an asset is one thing. What the company itself will take the next time it raises capital makes a significant statement about what Facebook is worth. Though Facebook has raised oodles of money – most recently the $100 million in debt financing it took from TriplePoint Capital — it undoubtedly will need more. When that happens, let’s say the valuation is still $3 billion. Microsoft would then have to write down 4/5 of its $240 million investment in Facebook. Not a big deal to Microsoft financially, but embarrassing all the same.

A final thought. Reading the purported details in Tech Crunch of the e-mail from Bill Dagley of Private Wealth Partners (I say “purported” because I have no way of verifying the veracity of an e-mail sent to Michael Arrington), I’m reminded how foolish it is to put anything sensitive in an e-mail these days — or ever. I’ve recently noticed an uptick in the number of people who pick up the phone to have a conversation they once might have e-mailed. It’s undoubtedly a healthy development, as folks like Eliot Spitzer, Frank Quattrone, and the two former fund managers at Bear Stearns assuredly would agree.

When word first leaked last week about the coming reorganization at Yahoo (YHOO) my immediate reaction was, ‘What, they didn’t do that two years ago?’ I had the same reaction when the shell-game-type shuffling finally was announced Thursday. Then came the following over my transom. Give it a read. It’s from a Yahoo employee who decided to e-mail me directly with a unique view of what’s going on inside the company. I guarantee it’s better than any analysis you’ll see in the media on the subject. It also makes you wonder, does Yahoo’s board, which includes corporate luminaries like VJ Joshi of Hewlett-Packard (HPQ) and Bobby Kotick of Activision (ATVI), have the slightest idea what’s up at Yahoo?

Here’s the e-mail:

“I wanted to let you know about some of the good things going on at Yahoo. We are poised to double free cash flow in two years; we have the right people in the right places; our senior management is aligned with our shareholders; our employees are fully behind our senior management; and our advertisers are delighted with our services. This is the dawning of Yahoo’s best era ever. Things could not be better!

Ok, so there are some details to be worked out about how we actually meet those revenue targets, the fact that our new org chart shows absolutely no changes at the top, and the fact that we can’t get our stock price anywhere near what Mircosoft (MSFT) offered. But those are really just details, aren’t they? A few headwinds now will only make our sailing that much smoother later.

Take the new re-org announced today as one example. It had only one objective: solely to make our organization better aligned with our corporate priorities. Perish the thought that it had anything to do with personal power plays or internal politics. Sure, we just had a major re-org in January, which was really just a completion of the re-org that we had in October. But we work in the Internet, and we have to be nimble and responsive to the market demands. Just by example, when Hillary Schneider was promoted in Spring of last year to run HotJobs, Autos, Real Estate, Local, Shopping, Travel and Personals, we were all moved across campus into one larger org for no reason other than to ensure that our customers would be better served. Then, when Hillary moved on to run Sales for Yahoo (but kept HotJobs) at the end of the summer and we were moved back to our old homes, it was only to meet the needs of our customers again. When that uber-org was divided up in November and Autos and Real Estate went to our old Media group while the others fell under the Search group, it was because our customers demanded it. When the head of this group switched places with the head of the Search group in January just in time to do annual reviews for all of the people in their new orgs, well, you knew all along that our customers would be reaping the benefits. Now that this re-org will put all of those properties back under Hilary - except for Local, which is going to be under the group called Global Products (just out of curiosity, what is the opposite of Local?) - I can say with the utmost confidence that our customers will be delighted with the greater efficiencies that this structure will bring. (As a side note, the Engineering team, which has for the past few years re-org’d in lock step with the business re-org’s will not in fact re-org in lockstep this time, because quite frankly, they don’t need to be better aligned with the business teams.)

Sure, we have lost a few executives over the last week - eight in six days by my count. The fact that so many are leaving in such a short period of time right after we announced the end of all discussions with Microsoft might appear to be a lack of confidence in our own prospects, but I can assure you that nothing could be further from the truth. If you read the official announcements, their motives were made clear: all of them had decided either to spend more time with the families or pursue other opportunities. End of story.

As for the Microsoft offer, well, I can’t emphasize how relieved we are that we did not sell ourselves short. All of us who are working in the trenches know the full potential of Yahoo! Sure, we may be losing market share in search to Google (GOOG) every month and we may be losing market share in pageviews to social networks, but our future has never been brighter! As the market grows and our share declines, our opportunities for growth only increase! Simple math there. We have another 80% of the search market left to capture - Google only has about 30%. Now, whose future is truly brighter?

As for the Google deal, HOORRAY! Now, you might be thinking that we employees - particularly those in Search - who have spent most of our waking hours trying to do battle with Google might in some way be disappointed that we are now getting into bed with the enemy. Au contraire! We love it! Nothing indicates a job well done better than outsourcing your own job to the competition. Am I right, or am I right? After all, it is not as if we had sold the entire search team to another company for a premium price - that would have been a slap in the face! By contrast, outsourcing as much of the search business to Google as legally allowed in exchange for near term cash, that is much more re-assuring. It tells us all that we are truly valued.

So, as you can see, things here are great. Hope you are doing half as well.”