The deal announced Monday is Mayer's boldest move since she left Google 10 months ago to lead Yahoo's latest comeback attempt. It marks Yahoo's most expensive acquisition since it bought online search engine Overture a decade ago for $1.3 billion in cash and stock.
Mayer told analysts that she is "making a sincere promise to not screw it up."
Yahoo is paying mostly cash for Tumblr, dipping into what remains of a $7.6 billion windfall reaped last year from selling about half of its stake in Chinese Internet company Alibaba Holdings Group. Taking over Tumblr will devour about one-fifth of the $5.4 billion in cash that Yahoo had in its accounts at the end of March.
Mayer praised Tumblr as a fount of creativity that attracts 300 million visitors each month. David Karp, a 26-year-old high school dropout who started Tumblr six years ago, will remain in control of the service in an effort to retain the same "irreverence, wit and commitment to empower creators," Yahoo said.
"David Karp is one of the most inspiring, insightful entrepreneurs that I have ever met," said Mayer, who worked closely with Google co-founders Larry Page and Sergey Brin during her time at the company.
Tumblr will fill Yahoo's gaping void in the realm of social media. Yahoo so far has had to connect its services to Facebook and Twitter to give its users a social networking outlet.
Tumblr, which will remain based in New York, has about 175 employees, while Yahoo has 11,300.
In his statement, Karp predicted Yahoo would help Tumblr grow even faster as he strives "to make the Internet the ultimate creative canvas."
The deal is expected to close during the second half of this year.
Tumblr will now play a pivotal role in Mayer's attempt to reshape Yahoo after her highly successful 13-year career at Google, which she helped surpass Yahoo as the Internet's most influential company. Since coming to Yahoo, Mayer has concentrated on redesigning services and bringing in more engineering talent through a series of small acquisitions that have collectively cost less than $50 million.
Yahoo will still focus on mostly small deals, Mayer said, but "Tumblr is a game changer," she assured analysts.
As popular as Tumblr has become, the service remains unprofitable. That is likely to raise questions about whether Yahoo paid too much in Mayer's zeal to gain control over a hot service. Facebook Inc. faced similar doubts last year when it bought Instagram, a rapidly growing photo sharing site. Facebook initially agreed to pay $1 billion in stock for Instagram, but the value had fallen to $715 million by the time that deal closed. Facebook still hasn't proven it will be able to make money off of Instagram.
Mayer's efforts at Yahoo have been well-received on Wall Street so far, although most of the 69 per cent surge in Yahoo's stock price under Mayer's leadership has been driven by the rising value of Yahoo's remaining 24 per cent in Alibaba. When Alibaba goes public within the next few years, analysts have estimated Yahoo could collect another $10 billion to $20 billion by selling the rest of its Alibaba stock.
If this deal pays off the way Mayer envisions, Tumblr could help Yahoo finally get its stock price to $33. That would be a major coup because many investors soured on Yahoo after a previous regime led by co-founder Jerry Yang squandered an opportunity five years ago to sell the entire company to Microsoft for $33 per share. The stock spent more than four years trading below $20 before the recent surge.
The shares added 6 cents Monday to close at $26.58.
The deal could backfire, though, if Yahoo's effort to make more money alienates a Tumblr user base that so far has been subjected to hardly any advertising during the service's six-year history.
Mayer said Yahoo will work with Tumblr to create ads that "are tasteful and seamless." The company expects Tumblr to start increasing Yahoo's revenue next year.
Mayer is betting that Tumblr will provide Yahoo with a captivating hook to reel in more traffic and advertisers on smartphones and tablet computers. That rapidly growing market is expected to become even more important during the next decade.
More than half of Tumblr's users connect to the service through the mobile app.
Tumblr also runs one of the world's busiest websites, featuring 75 million daily posts about everything from politics to pets. Advertising has been a missing ingredient so far as Tumblr, like many online services in their early stages, focused on building a loyal audience before turning its attention to making money.
The deal also has some symbolic significance for Yahoo, an 18-year-old company that had spent much of the past decade drifting under different management teams while Google Inc. overtook it in size and influence. At the same time, newcomers such as Facebook Inc. and Twitter began to command attention.
Yahoo flirted with potential acquisitions of Google and Facebook in those two companies' early days, only to have the talks unravel because Yahoo wasn't prepared to pay asking prices that were far below the current market values of Google ($300 billion) and Facebook ($63 billion). Yahoo also considered buying YouTube in 2006, only to be outbid by Google, which snapped up the world's leading online video service for $1.76 billion — a price that now looks like a bargain.
Tumblr could help Yahoo recapture some of its cachet with teens and adults in their early 20s, a demographic that has become tougher for Yahoo to reach in recent years as it fell behind the technological curve.
While Facebook has turned into a mainstream social network where even grandparents now connect family and friends, Tumblr has become one of the places where the cool kids hang out. The service says it has amassed more than 50 billion posts from 108 million blogs.
Having its own social networking service will give Yahoo more insights into the things that people like — a key to distributing ads to consumers. That data, in turn, should help Yahoo sell more ads and accelerate its revenue growth. After three successive years of declines, Yahoo's revenue rose slightly last year, but lagged far behind the growth at Google and Facebook. Mayer has vowed to bring Yahoo's revenue growth back to at least the level of the overall Internet ad market.
Karp's cut from the Yahoo deal is about $275 million. Most of the rest of the money will be paid to the venture capitalists that invested about $125 million into Tumblr. That list includes Spark Capital, Sequoia Capital, Greylock Partners, Union Square Ventures and Insight Venture Partners.
The Tumblr deal overshadowed Yahoo's previously scheduled announcement on changes to its Flickr photo-sharing service, including a boost in the amount of free storage to 1 terabyte, far more than what rivals offer. Like Tumblr, Yahoo got the photo service by buying a promising startup.
Associated Press writer Michael Liedtke contributed to this report.