Should Yahoo! Inc. (YHOO) Follow Jeff Smith’s Advice to Merge with AOL, Inc. (AOL)?

With the recent Alibaba Group Holding Ltd (NYSE:BABA) IPO, following which Yahoo! Inc. (NASDAQ:YHOO) had a huge inflow of cash, regarding which it has still not disclosed its plans, with many considering that the company should focus on returning cash to shareholders, and others opting for more acquisitions to increase the value of the company. In a new development, Jeffrey Smith of Starboard Value sent a letter to the company’s CEO, Marissa Mayer, having several proposals including a merger with AOL, Inc. (NYSE:AOL).

Jeff Smith

The news came as a big surprise, taking into account that Staboard has not officially disclosed ownership of Yahoo! Inc. (NASDAQ:YHOO) shares in its latest 13F filing or any consecutive filings during the last quarter. In the letter, however, Jeff Smith said that Starboard is “currently a significant shareholder” of Yahoo. Moreover, Mr. Smith said that Yahoo should focus on unlocking value from its stakes in Alibaba and Yahoo Japan and to deliver this value to its shareholders in a tax-efficient manner.

Regarding Yahoo! Inc. (NASDAQ:YHOO)’s aggresive acquisition strategy, Starboard considers that Yahoo! should stop pursuing further acquisitions, taking into account that the company spent $1.3 billion since the second quarter of 2012 for these acquisitions, while its revenue and EBITDA have declined.

Nevertheless, the most interesting point that Yahoo! Inc. (NASDAQ:YHOO) should consider, according to Mr. Smith is a merger with AOL, Inc. (NYSE:AOL), which in his words “could improve Yahoo’s competitive position.” The investor also thinks that the merger will help to reduce the costs of the company and to monetize Yahoo’s non-core equity holdings in a more efficient way.

“We trust the Board and management will do the right thing for shareholders, even if this may mean accepting AOL, Inc. (NYSE:AOL) as the surviving entity in a combination, should that be the best and most tax efficient structure,” Jeff Smith said in the letter.

In fact, attention from activist investors might help Yahoo! Inc. (NASDAQ:YHOO)’s struggling core business as it did in the past. Earlier in August we analyzed Dan Loeb‘s activity within the company, which, among other things led to the appointment of Marissa Mayer as the company’s CEO which helped a lot to turn things around.

Now, with Jeff Smith engaging with the company’s management, Yahoo! Inc. (NASDAQ:YHOO) might once again improve its financial situation, because, even though, its core business is struggling, the company has a lot of opportunities it can explore with its non-core equity stakes in Alibaba and Yahoo Japan.

On his part, Mr. Smith has a very good track record at helping companies to unlock shareholder value and improve their situatuon. He is currently conducting a pretty successful proxy fight with the Board of Directors of Darden Restaurants, Inc. (NYSE:DRI) where Startboard intends to replace the whole slate of directors with their nominees. Moreover, Mr. Smith is trying to push Wausau Paper Corp. (NYSE:WPP) and MeadWestvaco Corp. (NYSE:MWV) to take some steps to improve the sharehlder value of the companies.

A couple of days ago, author and investor Josh Brown, during an intervention on CNBC, said that there is a big chance that some big activist investors such as Carl Icahn or Bill Ackman might also express their interest in Yahoo.

As the history tends to repeat itself, Yahoo! Inc. (NASDAQ:YHOO) should probably take notice of the suggestions outlined by Mr. Smith in his letter to Marissa Mayer and look for ways to maximize its shareholder value.

Disclosure: none