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SHANGHAI/NEW YORK (Reuters) - Yahoo Inc will sell as much as half of its 40 percent stake in Chinese e-commerce powerhouse Alibaba Group for $7.1 billion, ending years of fractious talks over how to extract value from its most prized asset.
Yahoo also increased its stock buyback authorization by $5 billion to $5.5 billion as a result of the deal but said it might instead opt to distribute some of the proceeds through a dividend.
The sale, announced on Monday, gives Yahoo $6.3 billion in cash and up to $800 million of new Alibaba preferred stock. After taxes, Yahoo will clear $4.2 billion.
Yahoo shares began rising Friday as word of the imminent deal spread. They increased as much as 3.8 percent in trading Monday before ending the day up 1 percent, or 16 cents, at $15.58.
Under the deal, Sunnyvale, California-based Yahoo and fellow investor Softbank Corp of Japan agreed to cap their voting rights in Alibaba at below 50 percent. Limiting outside ownership was a major motivation for Alibaba Chief Executive Jack Ma because of new Chinese regulations on foreign-controlled Internet companies, a person close to Ma said.
In a round of talks that collapsed in February, Yahoo had tried to work out a complex spin-off of Alibaba assets that wouldn't trigger a big tax bill. But that deal foundered on how much value to assign Alibaba's Taobao retail operation and on how U.S. tax authorities would treat the maneuver.
"It just got too complicated. There were too many moving parts," one Yahoo person involved in the talks said. Yahoo said the new version, while taxable, preserved the possibility of future gains because it received the right to sell another 25 percent of Yahoo's stake at the share price of an initial public offering planned by Alibaba Group. Yahoo would retain the rest.
Yahoo investors and analysts expressed relief at the compromise, which they said should allow Yahoo's new management to focus on the considerable challenges in its core business.
"It's better to show a path to monetization rather than wait for tax efficiency if that was proving too difficult to achieve," said Ronald Josey, an analyst at Thinkequity LLC.
"Now this hurdle is over, shareholders are looking at how Yahoo could right the ship from a fundamentals perspective."
Yahoo has been trying for some time to cash in on its Alibaba investment, but its efforts have been hurt by management turmoil. While Ma had a strong rapport with Jerry Yang, the Yahoo co-founder who led the initial investment in Alibaba, ties between the two companies soured after Yang was replaced as chief executive in 2009.
The deal was announced just eight days after yet another management revamp at Yahoo, in which the company appointed a new interim CEO and gave three of 11 board seats to Third Point, a hedge fund run by activist investor Dan Loeb.
Interim CEO Ross Levinsohn said the timing of the deal was a coincidence, as Yahoo had been negotiating under his predecessor, Scott Thompson, who was ousted after four months. The new board was unanimous in approving the deal, according to a person close to the company.
Yahoo will consider collaborating with Alibaba on new initiatives, Levinsohn said.
"We're happy at the way this has evolved in the last few months," Levinsohn said, suggesting one option could be for Yahoo to help Alibaba expand beyond China. "It's a big step forward that we're talking about strategic initiatives."
Ma had sought to reclaim Yahoo's stake, which the U.S. company bought for $1 billion in 2005, in anticipation of a planned initial public stock offering.
Alibaba Group, valued at $30 billion to $35 billion, listed its Alibaba.com unit in 2007 and last February agreed to take it private.
"The valuation is reasonable ... but I don't think this is going to affect the IPO strategy," said Elinor Leung, an analyst at CLSA. "I don't think the IPO is going to be imminent, meaning this year. Net-net, this is going to be positive for Yahoo because you cash out on half the stake, but Yahoo's main worry is their U.S. business."
Alibaba, long the dominant player in China's booming e-commerce sector, said it would raise the money for the deal through a mix of cash, debt and equity.
Sources said the group was in talks with existing shareholders, including Singapore state investor Temasek Holdings Pvt Ltd, to raise about $2.3 billion in equity to partly finance the deal.
Yahoo confirmed that Alibaba would also look at private equity financing. Alibaba was not immediately available to comment and a Temasek spokesman declined to comment.
Temasek bought shares from Alibaba employees in September in a tender offer in which DST Global, Silver Lake and Yunfeng Capital also took part.
According to Basis Point, a Thomson Reuters publication, Alibaba is likely to increase a $3 billion loan for taking its listed unit private to $4 billion.
Yahoo's Alibaba stake and its 35 percent holding in Yahoo Japan -- jointly owned with Softbank -- are considered the most valuable pieces of the U.S. Internet company.
Analysts have said selling off its Asian assets would raise cash and simplify Yahoo's structure, simplifying the task for investors seeking to value its core operations.
Yahoo has also held sporadic talks about disentangling itself from Yahoo Japan, but Yahoo executives said Monday that they remained at some distance from Softbank on valuation and that no deal was imminent.
The Alibaba arrangement is an early boost for interim CEO Levinsohn, the fifth person in the top job in the past five years. Yahoo has suffered from falling revenue, layoffs, management reorganizations and executive departures.
Many analysts expect Levinsohn to re-orient the company to its media properties, including Yahoo Sports and Yahoo Finance, while focusing less on expensive technology efforts such social networking.
Finalizing a deal with Alibaba could allow Levinsohn to focus on a comeback plan, while potentially earning goodwill from investors, who are frustrated by missteps and poor performance.
"For Yahoo, this is something that needed to get done because Alibaba was having a bit of an issue with ... the group being so dominantly owned by foreign entities," Nomura Securities analyst Jin Yoon told Reuters.
"The China asset was kind of their crown jewel, so I don't actually expect Yahoo to fully depart from China, and I do expect Yahoo will have some sort of remaining involvement with Alibaba Group."
Yahoo and Alibaba will amend their existing technology and intellectual property licensing agreement. Alibaba will continue to operate Yahoo China under the Yahoo brand for up to four years.
Yahoo will be freed from restrictions on making other investments in China. Alibaba will make an upfront lump sum royalty payment of $550 million to Yahoo and pay royalties for up to four years.
UBS was lead financial adviser to Yahoo, while Credit Suisse advised Alibaba.
Additional reporting by Jonathan Gordon, Denny Thomas and Chyen Yee Lee in Hong Kong; Joseph Menn and Alexei Oreskovic in San Francisco; Saeed Azhar in Singapore; Supantha Mukherjee in Bangalore and Sinead Carew in New York; Writing by Ian Geoghegan; Editing by Muralikumar Anantharaman, Jeffrey Benkoe, Matthew Lewis and Steve Orlofsky