Yahoo, which bought 40 per cent stake in Alibaba Group in 2005 for about USD 1 billion, will sell 20 per cent of its holding to the Chinese firm.
In an agreement reached yesterday, Yahoo said they would receive USD 7.1 billion from Alibaba composed of at least USD 6.3 billion in cash and up to USD 800 million in newly-issued Alibaba preferred stock.
As part of the deal, Yahoo would sell the remainder of its Alibaba stake in stages.
"The deal provides for a staged exit over time (to Yahoo), balancing near-term liquidity and return of cash to shareholders with the opportunity to participate in future value appreciation of Alibaba," Yahoo said in a statement.
The future monetisation would happen when Alibaba goes public.
At the time of the IPO, Alibaba will be required either to repurchase one-quarter of Yahoo's current stake at the IPO price or allow Yahoo to sell those shares in the IPO.
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"...Agreement provides clarity for our shareholders on a substantial component of Yahoo's value and reaffirms the significance of our relationship with Alibaba," Yahoo Interim CEO Ross Levinsohn said.
"The transaction will establish a balanced ownership structure that enables Alibaba to take our business to the next level as a public company in the future." Alibaba group, Chairman and CEO Jack Ma said.
Yahoo, which has been struggling to increase its market share, intends to return substantially all of the after-tax cash proceeds to shareholders following the closing of the transaction.
While the form of the return of capital to shareholders has not yet been finalised, Yahoo's board has increased share buyback authorisation by USD 5 billion concurrently with this transaction.
In addition to the share repurchase deal, the companies have also agreed to amend their existing technology and intellectual property licensing agreement.
Among other things, this amendment will grant Alibaba licence to continue operate Yahoo-China under the Yahoo brand for up to four years at a royalty payment of USD 550 million.
The China based company will also licence certain patents to Yahoo. Yahoo will continue to be represented on Alibaba's board of directors with the right to appoint one of four existing directors.
Last week, Yahoo CEO Scott Thompson had quit the company amid allegations of manipulating his resume. This was the second time in less than a year, when Yahoo has seen the exit of its CEO.