The world's largest wealth management firm, UBS, issued a note this week advising investors that the unpredictable results of Google's adjustments to ad systems and algorithms, combined with an expected 3Q seasonal downturn in online advertising, makes investing in GOOG a risky proposition in the short-term, at least until 3Q results are published.

Longer-term, the note read, UBS continues to believe that Google is executing extremely effectively, and that it is closing many strategically important deals, partnerships, and key hires, as it builds itself for the long-term.

The analysts identified two major changes to Google's ad systems -- the landing page quality change in July and a quality score change for keyword and ad text in September -- and said both changes generally raise the minimum bid for advertisers. The former change was directed at a "small but important" group of advertisers that are effectively arbitraging the Google AdWords and AdSense systems. The latter change increased the minimun bid for a broad cross-section of "lower quality" ads.

Google changes its algorithms frequently, and UBS uses those changes to estimate Google's monetization potential quarter to quarter. However, UBS analysts said they were unable to quantify the economic impact this quarter.

"While some of the changes have increased minimum bids by at least 15%-25%," read the note, "we simply do not know how many advertisers and how many keywords of the total Google ecosystem were impacted."

Fascinating Description of AdWords Arbitrage

The UBS note also contains an in-depth explanation of how some users profit from the arbitrage (near-simulataneous purchase and sale) of AdWords.

The analysts explain that, at a high level, arbitrageurs can use Google's search and contextual ads to make money by buying traffic for a certain price and selling it for a higher price. Google changes the economics of that system when they raise minimum bids, effectively taxing arbitrageurs on their profit and pricing some out of the market. The figure below, from the note, shows how increasing minimum bids decreases an arbitrageur's profit.

The report explains three different systems of arbitrage: Contextual ad, comparison shopping, and squeeze pages.

In the the contextual ad arbitrage model, the arbitrageur places an AdWords bid. The ad, which shows up on, say, a Google SERP, leads to a landing page with Google AdSense. The operator the landing page generates more money from Google AdSense payments than it cost to buy the AdWord.

In the comparison shopping model, a shopping engine such as shopzilla or NexTag pays for a high-position AdWord that shows up in the top position on a SERP. The shopping engine also partners with retailers and receives money for referring traffic to those retailers. "If an arbitrageur (for example, a shopping engine) can pay less to get traffic from Google than it gets from a retailer who pays for a click through a comparison shopping site, it can earn the difference," reads the report.

In the squeeze page model, sponsored links on a Google SERP lead to a sign-up sheet for a referral. The arbitrageur pays a relatively low amount for the sponsored link on the SERP but receives a good deal of money from the third-party who owns the sign-up sheet. UBS uses the example of plastic surgery, where surgeons are willing to pay a great deal for leads because the conversion profit is high.