SAN FRANCISCO - An activist investor is urging Yahoo (YHOO) to buy rival AOL (AOL) to give the long-struggling Internet companies a better chance to compete against Google (GOOG) and Facebook (FB) in the digital advertising market.
Jeffrey Smith, who heads Starboard Value LP, outlined his rationale for the AOL Inc. deal in a Friday letter to Yahoo Inc. CEO Marissa Mayer and the company's board of directors.
The letter says Starboard has accumulated a "significant" stake in Yahoo, without providing specifics.
Yahoo didn't immediately respond to requests for comment.
Smith fired his volley at Yahoo just a week after the Sunnyvale, California, company reaped a $9.5 billion windfall by selling a chunk of its holdings in China's Alibaba Group.
Yahoo still holds a 15 percent stake in Alibaba (BABA) worth about $34 billion, an asset that Smith contends has been mismanaged. He says that Yahoo could boost its stock price by about $16 per share by coming up with a strategy that would minimize the company's taxes when it sells the rest of its holdings in Alibaba Group and another investment in Yahoo Japan.
One way this might be done would be to engineer a tax-free spin-off of Yahoo's Asian investments, though Smith didn't explicitly float that idea in his letter. He said Starboard has discussed several "alternative structures" for Yahoo's Asian investments with tax specialists.
As it is, Yahoo's stakes in Alibaba and Yahoo Japan are valued at a combined $42 billion. Before the letter was released, Yahoo's total market value stood at $39 billion -- an assessment indicating that investors put little or no value on the company's ongoing U.S. business while discounting for the taxes that currently would have to be paid in eventual sales of the Alibaba and Yahoo Japan stakes.
The prospect of a change in Yahoo's recent direction seemed to excite investors. Yahoo's stock rose $1.60, or 4.1 percent, to $40.55 in Friday's afternoon trading. AOL's stock added $1.36, or 3.2 percent, to $44.33 as investors reacted to a potential buyout bid.
After paying its taxes, Yahoo is expected to have an additional $6 billion in cash that could be used to buy AOL, whose current value is hovering around $3.5 billion. Yahoo has previously pledged to return about $3 billion -- half of its recent Alibaba windfall -- to its shareholders through stock buybacks or a special dividend.
Yahoo and AOL emerged as early Internet stars during the 1990s as people coming online for the first time flocked to their websites for news, search requests and email.
Although they still attract large audiences, both Yahoo and AOL have been eclipsed during the past decade as Google first established itself as the Internet's main gateway and then branched out into other directions while Facebook has built an addictive social network that's among the most popular apps on the mobile devices that increasingly are becoming the main pipeline to digital audiences. Both Google and Facebook have been capitalizing on their success by selling more digital ads while the market shares of Yahoo and AOL have been steadily shrinking.
Yahoo has gone through seven CEOS since 2006 trying to snap out of its financial funk. Its mostly fruitless attempts have placed the company in the crosshairs of three different activist investors -- billionaire Carl Icahn, hedge manager Daniel Loeb and now Smith.
Mayer, one of Google's first employees, has helped lift employee morale and sharpened Yahoo's focus on mobile devices since her arrival in July 2012. But so far she hasn't been able to accelerate Yahoo's revenue growth, even as advertisers have been increasing their digital advertising budgets. Mayer, 39, repeatedly has pleaded for more patience on Wall Street, saying it might take a few more years to engineer a turnaround.