But shareholders promised bigger piece of Alibaba profits.

Yahoo Inc. reported disappointing second-quarter earnings Tuesday but said it will retain more of its stake in high-flying Alibaba Holding Group and reward shareholders with at least half of the proceeds from the Chinese e-commerce giants initial stock offering.

The Alibaba announcement helped offset the impact of year-over-year declines in Yahoos earnings and revenue and a 7-per-cent drop in display advertising in quarterly results that missed analysts forecasts.

We are not satisfied, said Yahoo chief executive Marissa Mayer. Transformation is not a singular event, she added on a conference call with analysts.

We believe a transformation of this size and scale will take time.

Yahoo shares rose initially in extended trading on the expectation investors will receive a windfall from the holding of about 20 per cent worth $26 billion (U.S.) according to the Alibabas share offer prospectus. The stock closed two per cent lower after hours at $34.89 (U.S.).

Yahoo was originally required to sell 208 million shares or about 40 per cent but will now have to divest 140 million under a revised agreement between the companies.

Alibaba, run by Chinese entrepreneur Jack Ma, is readying a U.S. IPO this year that could rival the proceeds from Facebooks listing in 2012 and value the company at as much as $150 billion (U.S.).

We would like to take this opportunity to let our investors know that we are committed to return at least half of the after-tax IPO proceeds to shareholders, said chief financial officer Ken Goldman.

The Chinese online retailers initial public offering could be the largest ever in U.S. history. Yahoos Mayer, while benefiting from Yahoos stake in Alibaba, is struggling to deliver growth as she contends with popular rivals such as Google Inc. and Facebook Inc.

The big headwind (for Yahoo) is competition, said Sameet Sinha, an analyst at B. Riley & Co. who has a buy rating on Yahoos stock. The Facebooks and Googles are getting that much farther ahead.

While Yahoos stock has more than doubled since Mayers arrival, much of that gain is tied to the Web portals stake of about 23 per cent in Alibaba. The Chinese companys rapid growth has made it one of the most anticipated IPOs since Facebook in 2012 and Twitter Inc.s last year.

Analysts said the Alibaba news obscures core business challenges at Yahoo, which posted revenue after traffic acquisition costs of $1.04 billion in the quarter, a 3 per cent drop from the second quarter last year.

Yahoo reported net income for the second quarter of $269.7 million or $0.26 per share, compared to $331.2 million or $0.30 per share for the year-ago quarter.

Excluding items, adjusted net income for the second quarter was $381.7 million or $0.37 per share, compared to $385.9 million or $0.35 per share in the prior year quarter.

Analysts polled by Thomson Reuters expected the company to earn $0.38 per share on revenue of $1.08 billion.

While several areas showed strength, their growth was offset by declines, Mayer said.

She said Yahoos search and mobile search and display ad units had a strong quarter but display ads remain an area of investment and transition.

The Internet company is working to monetize technologies from the raft of companies acquired under Mayer over the past 20 months, including micro blogging platform Tumblr.

Money will get returned to shareholders shareholders profit, said Colin Gillis, an analyst at BGC Partners who has the equivalent of a hold rating on Yahoo. Acquisitions may not pan out.

Mayer has been investing in Yahoo, seeking to attract more users that should, in turn, attract more advertising dollars. That includes new mobile services focused on specific topics such as food, beauty and technology. The company has also redesigned its home page and acquired Tumblr, a blogging service that helps draw younger users to Yahoo.

Mayer needs to show her many efforts at Yahoo are actually producing more traffic and time spent on sites, said Martin Pyykkonen, an analyst at Rosenblatt Securities Inc.

The advertisers are only going to come back and spend in a meaningful way when theres an audience and when theres growth in that audience, he said.