What is Yahoo's Financial Exposure to Adware and Spyware? (YHOO)

Internet companies are becoming increasingly candid that the quality of their traffic is often worse than investors think. For example, on their Q2 conference calls Autobytel discussed weeding out low quality traffic, and Infospace revealed that it had significant exposure to Adware and Spyware. The Internet Stock Blog's initial coverage of the quality of traffic problem listed a danger list of stocks at risk from Spitzer’s attack on Adware that was later supplemented. Now, Spyware expert Ben Edelman provides more detail specifically about Yahoo's (ticker: YHOO) exposure. He writes:

At present, Yahoo has many PPC syndication partners -- apparently hundreds or thousands. (Yahoo does not disclose all its partners.) Finding all of Yahoo's rogue syndicators may prove hard, especially if partners have further partners of their own (as in the Direct Revenue / InfoSpace example, above). In this article, I've focused on a few large and well-known syndicators who rely on software installed on millions of PCs, but smaller players will be harder to find and identify. Nonetheless, I've found dozens of rogue Yahoo syndicators using only a single off-the-shelf PC in my lab. With all its resources, Yahoo can surely do far better. If improving the quality of Yahoo's syndication network requires making the network smaller, so be it: With its stock at a four-year high, Yahoo can afford to forego a bit of revenue.

...Beyond advertiser backlash and consumer demand, Yahoo faces regulatory pressure to avoid supporting spyware through PPC syndication. In the course of their investigation of Intermix, staff of the New York Attorney General revealed that Yahoo contributed 10% of Intermix's revenue. NYAG staff say they're "not ruling out" litigation against Yahoo for funding Intermix. More recently, rumors indicate a possible NYAG investigation of Direct Revenue. After Yahoo's support for Intermix, I suspect NYAG won't be pleased to see Yahoo funding Direct Revenue too.

Mr Edelman's full article documents abusive practices by Adware and Spyware vendors that monetize their traffic with ads provided by Yahoo. Full article here.

The key question for investors is: What is Yahoo's financial exposure to Adware and Spyware? That means:

• How much revenue does Yahoo generate by providing ads to unscrupulous "partners"?
• What is Yahoo's potential legal exposure to a suit by Elliot Spitzer and other state or Federal authorities? Remember, prior to its acquisition by News Corp, Intermix (ticker: MIX) settled the Spitzer suit for an "imputed liability [of] roughly $100 million for all claims within the US", according to Ben Edelman in a comment on this post.
• What is Yahoo's potential legal exposure to a suit by its advertising partners who could claim that they were mislead by Yahoo into buying ads on Adware and Spyware networks?

It would be interesting to hear what those who work in the industry think about this...

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Comments

[AdwareAdvisor:]

It is perhaps worth noting that the quality of traffic from adware sources is typically quite high. Much of the traffic is sourced from piggy backing (if you are polite) or stealing (if you are not) the traffic from the major search engines which is widely recognized as the source of the best quality traffic on the net.

This creates a dilemma for all affiliate networks. Everyone knows that that adware related traffic is questionable from an ethical perspective (and possibly/probably legal as well) but if it is delivering high quality converting traffic to the advertiser base, there is a strong financial incentive to continue to facilitate that flow of the traffic.

It is extremely difficult for an affiliate network to scrub its network of adware related traffic. The traffic is sourced only from machines that have the adware application installed and can be easily made to look like "normal" traffic. It takes a well trained eye to spot adware traffic and track down it's true source.

It is also extremely difficult to run a large scale affiliate network without multiple levels of affiliates. To properly police the adware traffic, you need to monitor not only the affiliates but the affiliates of the affiliates and the affiliates of the affiliates of the affiliates. A few "rogue" affiliates in the chain hoping to grab a quick dollar is all it takes to install adware on thousands of machines. And commercially it is virtually impossible to impose the burden of responsibility onto the important affiliates (the "super" affiliates) and their affiliates who are closer to the culprit. They wield too much power to be outright banned by the network so these matters are often addressed with by a slap on the wrist.

And it can be extremely difficult to get rid of adware traffic from a financial perspective. To clean a network, it involves the deployment of talented human resources (i.e. costs) to get rid of high quality traffic that advertisers pay for (i.e. revenue). Furthermore as the major search engines continue to capture more of the high quality traffic market, other networks find it harder to source good quality traffic for their advertisers. If traffic quality declines too much, advertisers can reduce their offers or leave. And then affiliates start to leave. It can create a downward spiral and there is a very real prospect that the network ceases to exist. To be sustainable in the long run, every network needs a consistent flow of high quality traffic. If the choice is between getting high quality traffic from adware and survival it is not too surprising what most people choose.

Face with all these issues, many networks have decided that the appropriate response is PR. Talk about click-fraud (which is not the same issue), upgraded terms and conditions (which are difficult to enforce), and upgraded investment in traffic quality technology (which doesn't flag adware traffic as it high quality) and hope a way to trade out of the adware mess will emerge.

Finally, all the major Internet players have a strong incentive to get rid of adware (when they focus their collective minds on the issue). Google, Yahoo, Microsoft and AOL are all losing traffic related revenue to adware networks. Dell's computers and Microsoft's operating system don't work properly with adware installed and they have to field the customer service calls. All the world's ISPs have to deal with adware related customer complaints. There is too much commercial power in all these companies combined with a bit of legal muscle from Spitzer etc for the adware industry to survive long term.

The real question from a stock performance perspective is when the adware industry all falls apart, which emperors' have no clothes? A bit more specific adware disclosure might be a start.

2005 Sep 01 08:57 PM