The purchase will boost Verizon's AOL internet business, which it bought last year for $4.4 billion, as it gains access to Yahoo's ad technology tools, BrightRoll and Flurry, and search, email and messenger assets.
Verizon, the No. 1 U.S. wireless operator, has in recent years looked to mobile video and advertising for new sources of revenue in an oversaturated wireless market. It has also scaled back on its Fios TV and internet service.
Verizon could combine data from AOL and Yahoo users in addition to its more than 100 million wireless customers to help advertisers target users based on online behavior and preferences.
"Yahoo gives us scale that is what is most critical here, Marni Walden, who is head of product innovation and new business at Verizon told CNBC, adding that the company's audience will go from the millions to the billions. "We want to compete and that is the place we need to be."
Yahoo Chief Executive Officer Marissa Mayer said on a conference call with investors that she planned to stay at Yahoo through the deal's close. Walden, who will head the combined company, told CNBC the new leadership team has yet to be determined.
"It's a decade of mismanagement that has finally ended for Yahoo," said Recon Analytics analyst Roger Entner. "It's the continuation of an extension of Verizon's strategy toward becoming a wireless internet player and a move away from (telecom) regulation for Verizon into an unregulated growth industry."
Shares of Verizon dipped 0.8 percent to $55.67, while Yahoo fell 2.6 percent to $38.37.
The integration of Yahoo will not come without challenges. Yahoo hired Mayer, a former Google (GOOGL.O) executive, as CEO in 2012 with a mandate to engineer a turnaround, but her strategy to focus on mobile, video and social content could not revive the company and reverse its sagging stock price.
In its latest results, Yahoo reported a second-quarter net loss of $439.9 million as it wrote down the value of Tumblr, the microblogging and social media service it acquired in 2013 for $1.1 billion.
With AOL and Yahoo, Verizon would still be far behind internet juggernauts Google and Facebook (FB.O). According to market research firm eMarketer, Yahoo is expected to generate $2.32 billion in net U.S. digital ad sales, while AOL is expected to make $1.3 billion in 2016.
Facebook and Google are forecast to deliver sales of $10.3 billion and $24.63 billion, respectively, by the end of this year, according to eMarketer.
The Verizon deal would transform Yahoo into a holding company, with a 15 percent stake in Chinese e-commerce company Alibaba Group Holding Ltd (BABA.N) and a 35.5 percent interest in Yahoo Japan Corp (4689.T) as well as Yahoo's convertible notes, certain minority investments and Yahoo's noncore patents.
Yahoo executives said the remaining company is structured to "indefinitely" hold its Yahoo Japan and Alibaba shares. They are worth about $40 billion based on their market capitalizations, while Yahoo had a market value of about $37.4 billion at Friday's close.
Yahoo will continue as an independent company until the deal receives shareholder and regulatory approvals, the companies said. It is expected to close in early 2017. It plans to change its name and become a publicly traded investment company.
Yahoo currently has $7.7 billion in cash, in addition to the $4.8 billion it will receive at the close of the deal, which it plans to return to shareholders, Yahoo executives said on the call.
Verizon prevailed over rival bidders, including AT&T Inc (T.N); a group led by Quicken Loans founder Dan Gilbert and backed by billionaire Warren Buffett; private equity firm TPG Capital Management LP [TPG.UL]; and a consortium of buyout firms Vector Capital and Sycamore Partners.
Under pressure from activist investor Starboard Value LP, Yahoo launched an auction of its core business in February after shelving plans to spin off its stake in Alibaba.