Thursday, September 11, 2008 Activist Investor: Why Google Cares About GeoEye

09/11/08 - 10:00 AM EDT
By Eric Jackson

GeoEye (GEOY Quote - Cramer on GEOY - Stock Picks) is a relatively small company that takes pictures of the Earth from three satellites it operates in space. You've probably never heard of it. However, Google (GOOG Quote - Cramer on GOOG - Stock Picks) co-founders Sergey Brin and Larry Page have. In fact, both attended last Saturday's launch of GeoEye's newest satellite at Vandenberg Air Force Base in California. In fact, Google's logo was on the side of the rocket that launched the satellite into space.

Why were they there, and what does it mean for Google and GeoEye investors?

I wrote about GeoEye earlier this year and have a large long position in the company. While the company has had issues largely of management's own making (delays in the launch of the satellite, minor earnings restatement and poor communication with investors), it has now overcome all of these with the near-textbook launch of the GeoEye-1 satellite last week.

GeoEye operates in a duopoly in the U.S. with DigitalGlobe, a smaller, private and less well-capitalized competitor. Both companies take geospatial images of Earth and sell those to governments and commercial customers. Until the last six months -- when GeoEye gave up some market share to DigitalGlobe, which launched its newest satellite in the sky last fall -- GeoEye was a $200-million-a-year company with 45% operating margins. It will now quickly return to that size and much more in the next year.

GeoEye-1, the satellite launched last weekend, is a game-changer for the industry. It's the first satellite to take color images of earth with the highest resolution. If you want to snap some images of a baseball plate at your local park, GeoEye-1 is up to the task. DigitalGlobe, assuming it goes public in the next year, will not leapfrog GeoEye with a better satellite for at least two years.

From a valuation perspective, GeoEye is compelling. The stock closed Wednesday at $26.31. Assuming the company returns in 2009 to its revenue run rate of six months ago, GeoEye is trading at 5.2 times 2009 earnings. BCC Research estimates that GeoEye's industry market is increasing from $1.9 billion this year to $3.2 billion by 2012. With that type of growth rate, a valuation of 12-15 times 2009 earnings is more than justified for GeoEye today, which would put shares at $60-$76.

The largest risk facing GeoEye -- and weighing on the stock -- had been the prospect of an unsuccessful launch of GeoEye-1 last Saturday. That risk is now past. In 30-45 days, GeoEye's largest customer, the National Geospatial-Intelligence Agency for the U.S. government, will sign off on the quality of the first images and start to place orders with the company.

The Google Factor

All of these valuation assumptions don't take into account that GeoEye announced, just days prior to the launch, that it would provide images from GeoEye-1 to Google exclusive of other online portals. The company has yet to give financial details of the arrangement, but Google clearly cares about GeoEye, as the attendance of the founders at launch confirm.

GeoEye is strategic to Google from a couple of angles. First, GeoEye will provide images to Google Earth and Google Maps. More importantly, GeoEye is intimately tied with Google's plans for Android, the mobile operating system it will roll out to handset providers later next year. Google is effectively buying proprietary mapping technology from GeoEye that can be later integrated into new location-based services we have not yet seen.

For example, with high-resolution images from a satellite that circles the earth several times a day, it becomes possible to integrate real-time traffic information when plotting traffic directions. It also becomes possible to easily track GPS-equipped vehicles.

GeoEye also has significant mapping tools that can be used to analyze multiple or time-series images, an interesting feature that could be interesting for Google Earth and Google Maps to implement.

If the connection between Google and GeoEye came down to merely improving Google Maps, you might have expected a Google product manager to attend last week's launch, not the co-founders. The fact is that Brin and Page have a personal interest in space. From investing early in Google Earth to last year's news that Brin signed up to take a personal space flight in 2011.

While some Google critics have poked fun at the company's interest in space, you cannot watch a news broadcast now without seeing some wide-angle image of a country that zooms into the city or location of interest to the story courtesy of Google Earth. There is also a long-term secular trend that we want to know exactly what's happening now in any place globally. The most accurate and up-to-date images of earth are part of that trend, and GeoEye-1 falls in the sweet spot of that demand. Google intends to take advantage of that (to say nothing of the government's continued interest in this information).

Put all of this together and you need to attach a premium to GeoEye's shares as a potential takeover target by Google beyond the price target I mentioned earlier. GeoEye is currently putting together plans to build GeoEye-2, its next-generation satellite for launch in 2011. Google just might want to have that satellite exclusively for its own use. If so, Internet giant would likely want to purchase the company in the next six months, before others agree to funding terms with GeoEye to develop that satellite.

Keep your eyes on the sky for a fast-rising GeoEye stock price.

At the time of publication, Jackson was long GeoEye.

Eric Jackson is founder and president of Ironfire Capital, LLC, and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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