Inside Yahoo's troubled advertising business

Between a sinking stock, an embattled CEO and restless investors demanding that the company be dismantled, these are not great days for Internet pioneer Yahoo.

Now add one more headache: The company's ad business, which brought in $1.15 billion in the second quarter of 2015, is rife with ad fraud, multiple sources told CNBC.

Executives at several media companies and media advisory firms with direct dealings with Yahoo's ad business said the company's programmatic video ad platform generates mostly fraudulent ad traffic, and otherwise does not work as promised. The platform is largely powered by BrightRoll, which was acquired by Yahoo in November 2014.

One company that used Yahoo's programmatic video ad platform said it discovered 30 to 70 percent of its ads were not running in areas where Yahoo was claiming they were. Most of the problems were tied to the fact that although it was paying $20 CPMs (cost per thousand views) for pre-roll advertising (ads that appear before a video), its ads were appearing in videos inside banners, which should have only been one-tenth of the price.

Another source said that it found BrightRoll's traffic was mostly coming from data centers' IP addresses, suggesting most of the ad views were nonhuman and fraudulent.

A Yahoo spokesperson denied the claims, and in a statement to CNBC, the company said: "Yahoo has always taken the integrity of ad inventory and traffic quality very seriously. We are leading the industry forward by allowing independent viewability and fraud measurement across our ad platforms through well-known and accredited, third party measurement partners."

"[W]e are committed to delivering value and results for our advertisers. ... We have focused on integrating advanced data, targeting and measurement capabilities across our advertising technology, including BrightRoll, to provide control and transparency, while driving results for advertisers," Yahoo said.

To be fair, ad fraud is a widespread problem not limited to Yahoo. A report by Distil Networks in October claimed that advertising fraud would cost the industry about $18.5 billion a year. For perspective, the Interactive Advertising Bureau projected that U.S. digital ad revenue reached $27.5 billion during the first six months of 2015.

Ad fraud occurs when digital advertisements are not being seen by the viewers companies paid to get in front of. In addition to creating nonhuman "impressions" or page views through bot networks, other known ad fraud practices include placing 1 pixel-sized advertisements on trusted websites which are invisible to the human eye. Sometimes, advertisements don't appear on the media sites or places the paying company believes they are.

Yahoo's advertising sales team also has its own set of problems. One media advisory firm that was negotiating a deal to live-stream a major sporting event with premium online video hub Yahoo Screen said the offer ultimately failed due to the ineptitude of the sales team, and major issues with its automated or programmatic ad platform infrastructure. It claimed the monthslong back and forth was filled with "communications breakdowns" and "smoke and mirrors" about how well Yahoo's ad technology could actually function.

Another media partner claimed that during the course of working with Yahoo, the company lost hundreds of ad partners because it was unable to articulate how brands would be able to take advantage of its self-proclaimed high-quality content. Part of the problem was that the technology behind Yahoo's ad management system was broken, making it unable for them to fulfill client benchmarks.

Two other people with direct dealings with Yahoo's ad business mention that the advertising community has still not forgiven CEO Marissa Mayer for blowing off several key client meetings at Cannes in 2014. The general consensus between them is the ad community views Mayer still as an outsider due to her engineering background, and believes she hasn't made the strides to understand the advertising business.

These stories come at a time when Yahoo, especially its media and advertising business, doesn't need more bad news. On Thursday, Business Insider reported that Yahoo was going to layoff at least 10 percent of its workforce, mostly from its media, ad platforms and European operations. The previous day, investor Starboard Value wrote a strongly worded letter to Yahoo calling for the removal of Mayer and her team.

Earlier this week the company confirmed it closed down Yahoo Screen which was the home for its original series including new episodes of NBC's cast-off series "Community" and the live-stream of the 2015 NFL Bills versus Jaguars game in London (NBC is a sister company to CNBC, both are owned by NBCUniversal). A rep told Variety that the company constantly reviews its products, and was transitioning Yahoo Screen videos to its digital magazines and other properties.

One of Yahoo's major problems is lack of a clear content strategy, according to Yahoo's former head of sports, entertainment and studios, David Katz. He currently is the CEO of digital sports magazine ThePostGame — which Yahoo co-launched in 2011. (The two companies still have a content-sharing agreement.)

During Katz's tenure, he claimed the company was focused on hiring quality writers and dedicated resources to reporting the news. Now, he feels the company disjointedly latches onto major and cultural events without having a fundamental news base, which can be expensive.

For example, Yahoo reportedly paid $20 million to the NFL for streaming rights for the London game. It also lost a total of $42 million in Q3 on its video assets, lead by the fresh episodes of "Community," as well as its original series "Sin City Saints" and "Other Space."

On top of that, Katz believes user experience on the website has made it hard to find relevant content. It can all be tied to Yahoo's focus on algorithms and programmatic functions, he said.

"I believe Yahoo content has really lost its soul in the process," Katz said. "Going out and spending a lot money on a few big price products, be it 'Community' or Katie Couric is not a strategy in itself. They were focused on putting a cherry on top of a sundae, but all the ice cream had melted. No one wants to eat that sundae."

Pixalate's Global Seller Trust Index — which ranks more than 250 ad exchanges on the kinds of traffic seeing these advertisements (human or nonhuman) among other factors — ranks Yahoo's platform 48th, with No. 1 being the best.

Yahoo bought BrightRoll in November 2014 for $640 million in cash. In September 2015, Yahoo united all its programmatic ad tech under the BrightRoll brand, including analytics firm Flurry, Yahoo premium inventory and Gemini native video supply.

UPDATE: The story was updated to include Yahoo's updated statement denying the claims. It also now reflects that Yahoo lost $42 million mostly from its shows "Community," "Sin City Saints" and "Other Space," not just from the cost of purchasing "Community" as originally stated.