UPDATE, 7:10 AM: AOL’s hitting 52-week highs with its stock floating around $26.30 in early hours trading, up more than 42%. Miller Tabak & Co analyst David Joyce raised his target price to $30 from his short term expectation of $22 and long term prediction of $27. He notes that AOL is keeping patents that “are still in areas critical to AOL growth, including advertising, search, content generation & management, social networking, mapping, multimedia/streaming, and security.” Microsoft is getting ”access to protection in areas it deems strategic such as advertising and webmail.”

PREVIOUS, 4:08 AM: AOL shares are up more than 35% in pre-market trading moments after CEO Tim Armstrong agreed to unload more than 800 patents in a portfolio that he recently referred to as “beachfront property in East Hampton.” AOL says it will “return a significant portion of the sale proceeds to shareholders.” The company will decide what form the investor benefit will take by year end, when it expects the deal to close. Armstrong has been under intense pressure to do something with the patents which involve processes for handling things like e-commerce, travel navigation, and search-related advertising. Activist investor Jeffrey Smith, whose Starboard Value owns 5.2% of AOL, recently said that Armstrong should treat a potential sale with “a sense of urgency due to the relatively short remaining lives of some of the material patents.” Armstrong says that the deal “unlocks current dollar value for our shareholders and enables AOL to continue to aggressively execute on our strategy to create long-term shareholder value.” Microsoft has agreed to pay AOL $211.2M if regulators block the deal, according to an SEC filing.

Here’s the release:

NEW YORK– AOL Inc. (NYSE: AOL) (the “Company”) today announced that the Company has entered into a definitive agreement to sell over 800 of its patents and their related patent applications to Microsoft Corporation (NASDAQ: MSFT) (“Microsoft”) and to grant Microsoft a non-exclusive license to its retained patent portfolio for aggregate proceeds of $1.056 billion in cash.

Following the sale, AOL will continue to hold a significant patent portfolio of over 300 patents and patent applications spanning core and strategic technologies, including advertising, search, content generation/management, social networking, mapping, multimedia/streaming, and security among others. AOL also received a license to the patents being sold to Microsoft.

The patent sale includes the sale of the stock of an AOL subsidiary upon which AOL expects to record a capital loss for tax purposes and as a result, cash taxes in connection with the sale should be immaterial. Additionally, AOL expects to utilize approximately $40 million of its existing deferred tax assets, representing approximately 20 percent of its total deferred tax assets, to offset any ordinary income taxes resulting from the license of its remaining patent portfolio.

AOL management and its Board of Directors intend to return a significant portion of the sale proceeds to shareholders and will determine the most efficient and effective method to do so prior to the closing of the transaction. Pro forma for the sale and license, as of December 31, 2011, AOL would have had approximately $15 per share of cash on hand.

“The agreement with Microsoft represents the culmination of a robust auction process for our patent portfolio,” said Tim Armstrong, AOL’s Chairman and CEO. “We continue to hold a valuable patent portfolio as highlighted by the license we entered into with Microsoft. The combined sale and licensing arrangement unlocks current dollar value for our shareholders and enables AOL to continue to aggressively execute on our strategy to create long-term shareholder value.”

“This is a valuable portfolio that we have been following for years and analyzing in detail for several months,” said Brad Smith, General Counsel and Executive Vice President, Legal and Corporate Affairs, Microsoft. “AOL ran a competitive auction and by participating, Microsoft was able to achieve our two primary goals: obtaining a durable license to the full AOL portfolio and ownership of certain patents that complement our existing portfolio.”

The transaction is expected to be completed by the end of 2012, upon the satisfaction of customary conditions and regulatory approvals, including expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.

Evercore Partners and Goldman Sachs acted as financial advisors and Wachtell, Lipton, Rosen & Katz and Finnegan, Henderson, Farabow, Garrett & Dunner acted as legal counsel to AOL in connection with the transaction.