I was positive that this has been discussed before on another forum, but I cannot find the link.
"Well, we can't kill the guy, no matter what he signed. Let's get Tanaka, our best guy to take a shot at the guy and deliberately miss. Heck, if we're going to do that, let's get Tanaka and five more of our best shooters out there to deliberately miss. That way, Ueshiba Sensei doesn't get killed and our school won't be shamed for having killed him or having backed down."
In any case, as I recall, the discussion was similar to what Andy wrote. The army shooters were unwilling to kill an innocent man, and O Sensei recognized this. The hunter, for whatever reason, was willing to kill an innocent man and O Sensei also recognized this and withdrew the challenge.
At least, that's how I recall the thread going, but I certainly could be wrong in my recollections.