Tuesday, May 12, 2009

DigitalGlobe IPO Could Be Boon for GeoEye

5/12/09 - 01:08 PM EDT


[Note: after this story was published GEOY saw its shares sink when management mentioned on their conference call that 1 type of photo taken from their new satellite was a mix of black and white with color. They discovered it 2 days ago and couldn't say what, if any, impact it would have on future revenues as they were determining what happened. Investors sold first and asked questions later and -- to be fair -- GEOY management should have been more crisp in their answers. The stock has bounced off its lows. It's also a volatile stock during options week.]

GeoEye(GEOY Quote), the geospatial imagery company that sells images to corporate and government customers taken from its satellites, has received extra attention this past week because primary competitor DigitalGlobe (which will hold the ticker DGI) is holding a rare IPO on Thursday.

This situation could be similar to what happened when Visa(V Quote) went public after MasterCard(MA Quote) -- DigitalGlobe's IPO should bring a big boost to GeoEye's valuation.

In the two months leading up to Visa's IPO last spring, MasterCard's stock price increased 26%. Following the IPO, MasterCard kept chugging, rising 24% over the two months post-IPO, which was better than Visa's 18.6% growth over the same period.

DigitalGlobe and GeoEye essentially operate a duopoly in the United States. Although they both compete fiercely for new business, they share a number of the same customers such as the National Geospatial-Intelligence Agency (NGA).

They have expertise in launching and deploying specialized satellites that can take pictures of a home plate from space -- in color. That's helpful for mapping, planning and, of course, national security.

There are very high barriers to entry in this business and it's not well known that the NGA funds the development and launch of these two companies' satellites. Their largest single customer has a built-in incentive to buy images from both.

Until Thursday's IPO, GeoEye has been the only public company in this duopoly, so the comparisons to judge valuation have been not ideal. Being a smaller-cap company also has led many to pass over GeoEye in the last year, especially as delays occurred around the launching of its latest satellite last fall and NGA giving the thumbs-up to the quality of the images coming from the new satellite (which was finally launched in March).

GeoEye's first-quarter numbers released last night were a positive surprise. Quarter revenue of $45 million exceeded analyst estimates of $41 million and was up significantly from a year-ago $35 million. Earnings per share were -9 cents, down from -5 cents a year ago but way ahead of analysts' estimates of -25 cents.

What's most impressive about these numbers is that the NGA only gave the green-light to the new GeoEye-1 satellite in late February. At that point, the previously announced service agreement had NGA committed to purchase at least $12.5 million per month for the next year or $37.5 million per quarter.

However, on the earnings call management indicated that very little revenue from this agreement was recognized in the quarter, suggesting that demand from other customers for GeoEye-1 images - those who didn't have to wait on the NGA's operational approval before purchasing their images -- was high.

It's especially intriguing to speculate how much Google(GOOG Quote) is paying for these images. GeoEye struck a deal with Google last fall prior to the satellite launch and stuck the Google logo on the side of the rocket.

This precluded GeoEye from selling images to Microsoft(MSFT Quote) or Yahoo!(YHOO Quote). GeoEye's management has yet to reveal the financial terms of its deal with Google, but the strong revenue growth gives some hope for continued ramp-up in the coming quarters.

From a cost perspective, some in the media have discussed GeoEye cash situation vs. the large costs of developing new satellites. The latest quarter's loss might make observers wonder if there's a lot to get excited about this business, even with growing revenue.

These concerns are overblown for a number of reasons. GeoEye went through a recent accounting restatement that ended in the first quarter and significant professional service fees were associated with this. In fact, SG&A for the quarter was up $3 million to $10 million compared to a year earlier, but most of those costs are one-time.

Revenue should continue to ramp up to historical operating margins of 45%. The company should be growing its earnings and cash over the next 18 months. Management also discussed several new hires the company is making in different areas of the business in anticipation of future demand. In addition, any new satellite development costs will be shared with the government as has been the case over the last few years.

In the last two months, GeoEye's stock price is up 34%. I suspect the stock will keep chugging as a much wider audience comes to understand the geospatial industry, thanks to the media attention focused on Thursday's DigitalGlobe IPO.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider GeoEye to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

At the time of publication, Jackson was long GeoEye.

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

Originally published in TheStreet.com

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