Terra, a Spanish Internet service provider, is offering a stock swap that values Lycos around $97.55 a share, assuming Terra's stock does not fall more than 20 percent.
Bertelsmann, the European media giant, is going to buy advertising and services from the combined company valued at $1 billion over five years and will offer preferential access to its content.
The combined company will be based in Waltham, Mass., with Lycos chief executive Bob Davis and chief financial officer Ted Philip remaining in their posts. Juan Villalonga, the chairman of Terra Networks' telecommunications parent, Telefonica, will be chairman.
Called Terra Lycos, the company will have operations in 37 countries, including in high-growth markets in North America, Latin America, Asia and Europe. The deal is expected to close in the third quarter of this year, provided it receives shareholder and regulatory approval.
"Overnight in one fell swoop, this company has jumped from strong Internet competitor to a global powerhouse," said Lycos' Davis. "In one transaction, we have truly transformed the industry."
Added Villalonga: "The combination of Terra and Lycos, supported by strategic relationships with Telefonica and Bertelsmann, creates a new media powerhouse with a scale unmatched by any other Internet or media company."
Despite the run-up in Lycos' shares in anticipation of the deal today, they are still trading well below the announced acquisition price.
"It's too early to read into the price gap between the stocks," said Arthur Newman, an Internet analyst at ABN Amro. "There was a gap between Time Warner and AOL when that deal was announced, but it closed in a few days."
Newman says that it takes some time for the news to filter into the markets, and that people prefer to mull over the terms of a deal before moving in either direction.
He believes investors that specialize in arbitrage will hold back initially.
"They are the people who will close the gap," he said. "The massive trades the arbitrage investors make, in this case shorting Terra Networks and hoarding Lycos, will eventually close the difference, but the deal-makers like to know the landscape before they dive in."
Although a shakeout in the portal market has been expected for some time, the deal raises the stakes for global Internet competition.
Terra Lycos also will own 49 percent of a new wireless joint venture being formed in partnership with Telefonica, the telecommunications giant that is Terra Networks' parent.
Telefonica will underwrite a $2 billion rights offering by Terra Networks before the close of the deal. As a result, Terra Lycos is expected to have more than $3 billion in cash after the offering, making it "one of the most highly capitalized Internet companies in the world," Terra Lycos said in a statement.
The Terra Lycos board will have 14 members, including Villalonga and 10 other Terra Networks designees, as well as Davis, Philip and one other Lycos designee. Davis also will join the board of Telefonica Media, the company's media subsidiary.
Lazard Freres served as financial adviser to Terra Networks, and Credit Suisse First Boston served as financial adviser to Lycos.
Terra and Lycos said they expect pro forma 2000 revenues of approximately $500 million; the companies said that together they have an estimated 50 million unique users and 175 million page views per day.
Both companies lost money last year. Lycos lost $52 million on $135.5 million in sales, and Terra lost 173 million euros ($157 million) on sales of $78.5 million.
The Spanish- and Portuguese-speaking market is considered a choice field. In Latin America alone, analysts predict the number of Internet users to jump sevenfold by 2003.
That potential has sparked intense competition among Internet companies, which are planting their flags all across Latin America.
A host of smaller sites, such as New York-based StarMedia Network and Argentine El Sitio, aim to gain a foothold in this market, alongside major Latin media companies. Grupo Televisa, the biggest Spanish-language media group in the world and Mexico's dominant broadcaster, is set to launch its own Web portal, Esmas.com.
The trend has even drawn major Latin stars to back some of these ventures. Earlier this year, Julio Iglesias and Latin American TV star Don Francisco invested in one of the new Latin America-focused Internet firms, Aplauso.com, which will go live this summer.
These companies face increasing competition from U.S.-based giants such as Microsoft, Yahoo and America Online.
AOL plans to take its Latin American unit public and to launch subscription-based online services and Internet portals throughout the region. In October, Microsoft said it would join with Telefonos de Mexico, the biggest Mexican telephone company, to develop a Spanish-language Internet portal for the Americas.
Brazil is already the scene of a turf war between the region's largest Internet provider, Universo Online, and AOL's Latin American subsidiary.
Last month, Universo, which has exclusive rights to many of the country's magazines, slashed prices to compete with AOL, which began flooding the country with free Internet access offers last month in a bid to win some 700,000 Brazilian customers.
News.com's Sam Ames, Reuters and Bloomberg News contributed to this report.