Click-fraud & the public Internet companies

Two recent Internet conferences (Majestic's and Jupiter's) highlighted the growing problem of click-fraud. Speakers described how companies are hiring other people to click repeatedly on pay-per-click ads from their competitors. But nobody mentioned that the problem is far more acute with public companies. In fact, individuals can directly impact the financial results of public companies without it costing them a penny.

Owners of ASKJ, FWHT, GOOG, MAMA, SHOP and YHOO stand to gain, while owners of AMZN, ECST, and OSTK should be worried.

What makes this particularly interesting is that despite its name,
click-fraud is not illegal, and there's practically nothing the victims
can do to stop it.  Here's how this will play out:

Companies wishing to trash their private competitors can hire another company to repeatedly click on pay-per-click (PPC) ads.  The competitor's advertising expenses rise, but there's no parallel rise in sales and profits.  While this is sleazy, it's not illegal.

But now let's say you own stock in a search engine company - Ask Jeeves (ASKJ), FindWhat (FWHT), Google (GOOG), Mama.com (MAMA), Yahoo (YHOO) or Shopping.com (SHOP).  You can boost the profitability of the company by repeatedly clicking on ads on those companies' home pages, and by encouraging your friends to do the same.  Click-fraud is boosting GOOG's and YHOO's revenues, but individual investors probably play little role in this.  The companies have such large revenue streams that the impact of individuals clicking on ads to boost revenues has little proportionate impact. 

But that's not true of Shopping.com (SHOP).  SHOP is a far smaller company, so a grass-roots campaign by SHOP shareholders to click on ads would have a dramatic impact on its revenues. Given SHOP's extremely high gross margins, the impact on profits - and thus the share price - could also be large.

The problem is even more acute on the short-side.  Say you're short stock of Overstock.com (OSTK).  You can repeatedly click on pay-per-click ads by OSTK and encourage your friends to do the same.  Smart investors will click on ads in the shopping engines. Why? Conversion rates are far higher for comparison shopping engines than general search engines, so the ads cost the advertisers more and yet they'll be less willing to pull the ads given the quality of the leads they generate.

This problem is probably exacerbated by the improving functionality of the shopping engines.  Shopping.com, for example, allows you to view pages showing only the products from a single vendor, in this case Overstock.com. It even allows you to view single categories of products arranged tightly in a grid and ordered highest-price to lowest-price (most expensive ad to cheapest ad?) such as this array of Overstock.com's jewelry. This makes it easy to click on multiple ads in seconds without having to search through entire pages, and even to email a link to pages of Overstock.com PPC ads to your friends (co-conspirators?) to click on.

How will this play out? Eventually click-fraud will hurt the search engines themselves as it will lower the value of pay-per-click ads and thus the amounts their customers are willing to pay. So the search engines will eventually eliminate click fraud using simple filters, such as refusing to bill for multiple clicks from the same IP address within a certain time period. 

But until that happens, retail investors can impact the financial results and stock prices of public companies. The smaller the company, the larger the impact.  Sleazy though it is, that's got to be good news for the small search engine stocks ASKJ, FWHT, MAMA and SHOP and bad news for the small Internet retailers ECST and OSTK.

At the time of writing I own stock in SHOP and I'm short stock in OSTK - it's been painful. Please note that, as with all Seeking Alpha articles, this is not a recommendation to buy or sell any stocks (it says nothing about valuation, for example), and that I could change my positions at any time without further notification.

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