Activist investor Starboard Value LP asked Yahoo Inc (YHOO.O) to drop plans to spin off its stake in Alibaba Group Holdings Ltd (BABA.N) due to tax concerns, and instead urged the company to sell its core search and display advertising businesses.
Yahoo's current net cash holding and the funds raised from a sale of the business could be returned to shareholders through buybacks and dividends, Jeff Smith, Starboard's head, said in a letter to Yahoo on Thursday.
The hedge fund, calling itself a "significant shareholder" in Yahoo, said it made the letter public as its efforts to talk to the company privately over the past year had not borne fruit.
Starboard had supported the planned spinoff of the Alibaba stake, currently worth about $30 billion, before the U.S. Internal Revenue Service in September denied Yahoo's request for a private letter ruling on whether the transaction would be tax free.
Yahoo's shareholders could end up paying roughly $12 billion in taxes if the IRS deems the transaction taxable after the spinoff, expected to close by end-December. Yahoo was worth about $31 billion as of Wednesday's close.
"If you stay on the current path, we believe the potential penalty for being wrong is just too great, and the potential reward for being right is not materially better than the other alternative," Smith said.
Yahoo declined to comment. Yahoo shares rose as much as 1.6 percent, but were flat at midday. Alibaba was up 1.4 percent.
Starboard said Yahoo had snubbed its requests to appoint Smith as a board member at least four times in the last four months.
Pivotal Research Group analyst Brian Wieser said Yahoo shareholders would likely back Starboard over the company's board if a proxy fight ensued.
"It wouldn't be a very hard proxy fight for Starboard."
Yahoo's search and display ad businesses, which account for a lions shares of total revenue, has been struggling and Chief Executive Marissa Mayer's efforts to revive the business have yielded little results.
Many analysts attribute little or no value to the business and say Yahoo's worth lies in its Asian assets: the Alibaba stake and a 35 percent stake in Yahoo Japan Corp (4689.T).
Yahoo's core business could attract private equity firms, media and telecom companies as well as firms such as Softbank Group Corp (9984.T), SunTrust Robinson Humphrey's Robert Peck said.
The Wall Street Journal reported on Starboard's proposals earlier on Thursday.
(Reporting by Devika Krishna Kumar and Lehar Maan in Bengaluru; Editing by Savio D'Souza)