Sep 30, 2014 · 4 minutes

The Marissa Mayer era of Yahoo came to be because of the wishes of an activist investor. So it seems oddly appropriate that Mayer's dreams of reviving Yahoo's growth may be thwarted by yet another shareholder activist, one who wants Yahoo to do exactly what Mayer does not: slash jobs and merge with AOL.

These activist investors normally circle around companies that are losing money in a grim cycle of irreversible decline. That doesn't describe Yahoo, whose core operations are profitable and stable. Instead, it's Yahoo's stake in Alibaba and Yahoo Japan that are the honeypot for outside investors.

Yahoo's Asian assets are proving to be a dual-edged blade for Mayer. They've shored up Yahoo's stock price as she engineers a costly and ambitious turnaround that needs years to take root. But they've overshadowed that turnaround, making Yahoo look like a successful hedge fund that just happens to run an online-ad empire.

So now that Alibaba has gone public, Yahoo's stake in the Chinese ecommerce giant is smaller (in exchange for a $5 billion payout) and investors don't need Yahoo as an Alibaba proxy. And Yahoo's core operations are moving into the spotlight again, leaving some investors with advice for Mayer.

One of them, Jeffrey Smith of Starboard Value, sent a letter to Mayer urging the company to sell Alibaba and Yahoo Japan assets, cut a half billion in jobs and other costs, stop spending on acquisitions, and transfer a good portion of the value these moves generate directly to shareholders. And, oh yeah, merge with AOL. This plan may derail Mayer's plans, but it could give $11 billion to Yahoo shareholders, so Starboard isn't likely to go away quietly.

Merging AOL with Yahoo may be an attractive idea to the former but for Mayer it's exactly the kind of move Yahoo should not be making. Its revenue has been fluctuating around $2.3 billion for the past four years. Its profits are still dependent on a dying dial-up subscription business. Above all, it's emblematic of the 90's era dot-coms in a way that Yahoo also is but desperately doesn't want to be.

But the thing is, whether Mayer likes it or not, even if an AOL merger is inevitable, it's probably the best long-term option for Yahoo. More than two years into Mayer's tenure, there just isn't evidence that Yahoo is gaining much traction in the evolving Internet industry. Yahoo has produced some slick and workable apps, but none of them feel essential. Look around at the home screens on your friends' phones – most have have Google and Facebook apps on them, rarely so Yahoo's. Tumblr too, while working fine, seems less essential than when it was independent.

These days, you need to be on home screens to make significant money on the mobile web. And as the Starboard letter points out, Yahoo's revenue has been stagnant while higher spending has driven down earnings. For two years, Mayer has been able to work on her turnaround with little interference from investors, but the Alibaba IPO seems to have started a countdown where suddenly Yahoo's core business needs to start showing results.

Merging with AOL makes strategic sense. Yahoo has been said to be hunting for an ad-tech company to buy, AOL's own success in building an online-ad business could fill that need. Mayer has been remaking Yahoo's work culture and nudging its apps onto more smartphones, but combining with AOL won't set any of those successes back. And both companies have been buying or building out media content that could also work well together.

There are arguments against such a move. Integrating two sizable companies would involve months of work that distracts from the overarching goal of staying competitive with Google, Facebook and others. But if Yahoo becomes an aggressive acquirer this would still be a risk as well.

Then there's the common observation some wag always makes when two aging companies merge: tying two bricks together won't make them float. But this is exactly the kind of consolidation that happens as business models mature. And neither Yahoo nor AOL is a “brick” that will be sinking quickly. Rather, they have years of low growth ahead, even if their ad offerings are increasingly becoming less central to the web, and more peripheral.

So an AOL merger won't give Mayer the kind of growth she dreams of for Yahoo, but neither is her turnaround after more than two years of trying. A merger, however, will reduce overlapping expenses and offer the potential for profit growth. And it allows both companies to better compete against their larger competitors in the display-ad market.

Yahoo had an opportunity to become a big player in the social Web five or ten years ago. It failed to capitalize on that chance, even though it bought promising startups like Flickr and del.icio.us, because of its bureaucratic culture. Mayer may finally be fixing the cultural problems, but only after Yahoo's chance to create renewed growth has passed.

And this is the core problem, one that predates Mayer. The prospect of Yahoo becoming a high-growth company in the era of a social, mobile Web is receding, if it was ever there at all. When Mayer was name CEO, it looked doubtful anyone could save the company. Two years on, it's looking like Mayer has been doing a terrific job at a hopeless task of reviving Yahoo.

Whether Starboard gets all it's asking Yahoo for, the letter may have tipped the momentum toward an outcome that seems to have been Yahoo's fate all along: merge with the kind of aging, if healthy company Mayer wanted to keep Yahoo from becoming. It may not be the most glamorous fate, but now that the Alibaba factor is passing, it may be the best outcome Yahoo can expect.

[illustration by Brad Jonas for Pando]