I actually agree that Yahoo is undervalued. Yahoo is first in web-based email. They have made a number of very smart acquisitions that position them well for further building brand loyalty.
Flickr,
del.icio.us and
Upcoming are just a few of these smart purchases. Yahoo also understands the value and the importance of community, and how to build it.
Where Yahoo stumbled (and Google guessed correctly) is in the area of small transaction text ads (i.e. Google Adwords/Adsense). Only Google seemed to grasp the potential of this "long tail" market where virtually anyone can afford to advertise and nearly everyone can sell advertising on their blog or website.
In the display world, you previously had to commit to minimum ad purchases that priced a lot of small players out of the market. Google Adwords made it possible to test the waters with virtually no minimum investment other than your time and a few bucks.
The challenge for Yahoo is that Google currently has pretty well sewn-up the text-ad market. Yes, Yahoo and even Microsoft both offer text ad alternatives to Google Adwords, but if the publishers aren't using their ad code, there isn't enough impressions to attract the advertisers (and vice versa). You end up with a chicken-and-egg problem.
Yahoo is going to have to slog it out for a long while before they get the valuation they deserve (and the earnings to support it). Trouble is, I'm not sure the shareholders will wait patiently enough to see it happen.
Merging with AOL won't really strengthen Yahoo either, though it
might throw a monkey wrench into Microsoft's takeover attempt.
What would really help Yahoo now? Only a major misstep by Google. If Google were to inadvertently shoot its golden goose (Adwords/Adsense), maybe by pissing off a large number of publishers or advertisers, there could be a mass exodus to a competing ad system. This could result in a major shift in revenue; away from Google and towards Yahoo. It's a long shot, and not terribly likely given Google's track record, but it's about all Yahoo has to hope for.