FTC’s Warning – A Wake Up Call For Search Engines

Ashley is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The fact that a majority of internet users today have turned to smartphones and tablets for web search has hurt the profitability of internet search engines, including that of giants in the industry like Google (NASDAQ: GOOG) and Microsoft (NASDAQ: MSFT). What made things worse for these “know it all” companies is a recent warning that came up from the Federal Trade Commission itself.

Apparently, the FTC wants search engines to highlight paid ads separately from that of organic search results. It is a common practice in the online ad business to ambush paid ads inside natural search results. This increases the chances of a user intentionally or unintentionally clicking on an ad, which in online advertising terms means more money.

Although the rate at which this new regulation will negatively influence companies like Google and Microsoft is low, how it will affect companies that are largely dependent on search engine revenues like IAC Interactive (NASDAQ: IACI) is a bit of a concern. These are the companies that are trying to make ends meet because of the massive lead that Google and Microsoft’s Bing have, owing to higher volume of search queries.

Google: Tough times ahead

Google was the most affected by the recent increase in mobile-based search queries and the consequent decline in web-based search queries. This is because web pages contain a higher number of ads when compared to mobile-targeted pages.

A search engine update is expected soon, following the FTC’s warning to make paid ads that come on top of natural search results more prominent and distinguished. Google is way ahead of its competitors in terms of search volume, and, hence, might not seem to be too bothered about the FTC’s warning; however, there are many other issues that add up to the company’s concerns.

Google recently acquired device maker Motorola, which has been witnessing widening losses in recent days. The company has also been witnessing a fall in its ad prices. This came as a surprise for analysts who were expecting an increase in ad prices following the recent changes in the company’s advertising system. The changes were expected to save the industry from what could be an industry shift from web advertising to mobile based advertising in the future.

The company is maintaining a price to earnings ratio of 26, which means that Google has a lot of homework to do or else we could see a sharp decline in its share value, which is at an all time high.

Microsoft’s Bing: Bang on target

Microsoft has an opportunity here to hit Google right where it would hurt the most - search volumes. Bing is currently second in terms of search volume. Since ad profits from Bing do not matter much in terms of Microsoft’s total revenue, it could make use of the FTC’s recent regulation to increase the user friendliness of its search engine without being concerned about the ad profits, so as to increase the search volume.

The war for dominance over the internet between Microsoft and Google is sure to encounter a rough ride this quarter. However, Microsoft sure looks more appealing for growth investors because of its revenue potential and a trailing PE of 18.

IAC Interactive’s Ask.com - Needs to worry

IAC Interactive needs to be concerned the most about the FTC’s new regulations. The company is highly dependent on its search engine Ask.com when it comes to raking profits. The search engine’s revenue accounts for more than half of the total revenue. Moreover, the search engine is falling behind others like Google and Bing in terms of search volume by a huge margin.

The company needs to come up with a strategy that will help it increase its search volume slowly without compromising on ad revenue. Only then will it be able to maintain a steady growth of share value along with a decent PE of 22. Regardless of this, the company also needs to focus on mobile advertising, which will prove to be very relevant in the near future.

What’s in store?

The new regulations from the FTC are not going to be frowned upon by Microsoft at all, because a small decline in ad revenue will not hurt the company’s interests in any way. For Google, these regulations add up to the list of issues that the company has had to face recently. In addition, Google’s current share values are soaring high, which would make it a riskier bet for potential investors. In addition, it’s a wake up call for companies like IAC to review their current position in the industry and roll up their sleeves to prevent themselves from falling too hard.

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Ashley Sales has no position in any stocks mentioned. The Motley Fool recommends Google. The Motley Fool owns shares of Google and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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