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Shares of Yahoo! (YHOO) rallied after it was reported that AOL (AOL) and several private-equity firms may be exploring the possibility of making a buyout offer for the Web content provider. It has also been reported that News Corp. (NWSA) may get involved. This is highly speculative, however, and as far as we know, Yahoo! has not been approached in any way whatsoever by these concerns.

Before this particular transaction could take place, it's thought that Yahoo! would have to sell its stakes in China’s Alibaba Group and Yahoo! Japan, which together may be worth more than $10 billion, in order for a purchase by AOL and other possible interested parties to be financially viable (AOL's market value is roughly one-tenth that of Yahoo!'s). It's also thought that once a deal is complete, AOL would combine its content offerings with those of Yahoo!.

In this case, a merged entity may be better positioned to compete in the online advertising market with the likes of Google (GOOG) and Facebook. While Yahoo! attracts a large number of daily visitors, the advertising receipts have slumped as a result of heightened competition and tighter ad budgets. Meantime, the company has been able to increase earnings primarily by cutting costs.

This is not the first time AOL has shown interest. It approached Yahoo! in 2008, while it was considering Microsoft's (MSFT - Free Analyst Report) proposed purchase for $45 billion (more than twice Yahoo!'s current market capitalization). All merger talks fell through, though Microsoft ended up inking a search agreement with Yahoo!. Given that this recent news is rumor-based, we would not advise investors to commit to YHOO shares in hopes of a big windfall, which we believe is unlikely. Indeed, the stock has already backed off significantly from the high achieved immediately following the news.


At the time of this article’s writing, the author did not have positions in any of the companies mentioned.