Personally, Karo is my favorite fighter just due to his style. I love watching his fights, win or lose. I think he has a lot of talent, and he really surprising me in the Fickett fight with his improved stand up game. It wasn't amazing, but it was impressive to see how much he had improved.
As for Karo vs. Sanchez, Sanchez clearly won that fight. On the other hand, anyone who watches Karo's fights knows that he entered that fight in terrible shape for his normal standards (Even his former mentor Gokor commented on his poor shape in that fight). When he came back to fight Drew Fickett, he looked to be back in fighting shape. I think in a rematch, Karo would win. That "judo crap" most definitely did work on Sanchez, and I think if Karo was in better shape, he would have been able to capitalize better. Basically, if they were to rematch, I see Karo surprising Diego with better standup and better conditioning. If Karo has the gas to do what he does best for the entire fight, I see him being Diego's first upset.
Now, as to who Karo will fight? I think the discussion of a Karo vs. Diego 2 basically begs for a rematch. Even the UFC.com had it listed as their best fight on the front page. GSP has been set back with injuries, and Karo and Diego's last fight were on the same night. They'd both be equally healed and equally prepared for an awesome rematch. I would love to see that, and I have all the respect in the world for Diego - Diego is an awesome fighter who could very well one day be champ.
If Karo doesn't fight Diego, I'd like to see him go up against Koscheck. That'd be an interesting test. Karo is amazing at Judo, but could his Judo out do one of the best wrestlers in the game? Who knows.