Key Assumption for GeoEye (GEOY): Forward Earnings

I've written several times in TheStreet.com and RealMoney.com about GeoEye (GEOY). It's been a long holding of mine since March of 2008 and it's been a big disappointment overall.

It sells its Earth imagery take from its satellites to the US government, foreign governments and to commercial customers including Google (GOOG) for maps and their mobile apps.

The reason for my heartburn with this stock has been chronic delays of launching GEOY's latest satellite last year and then waiting on its approval by the federal government to begin the $12.5mm a month revenue payments. While the company has waited, its stock drooped.

Now, the satellite is approved and the company has switched on the meter for beginning to charge the government (we should start to hear more about this when the company holds its Q1 call). We also are still in the dark about how much GOOG is paying GEOY for its images (which are currently the state-of-the-art in that industry).

Assumptions about earnings for the next year are key in determining whether to buy in to the stock. At the moment, consensus EPS estimates for 2010 range from $0.78 - $1.84. Yet, analysts appear to be under-estimating how well this company does when revenues are flowing, with historical operating margins of 45%.

Back in 2007, the last time GEOY launched a new satellite, 15% of its $183MM in sales dropped to the bottom line. If GEOY hits its high revenue estimate of $320MM next year (and remember it just switched on a guaranteed contract from about half of that from 1 customer), 15% of that would be $48MM or $2.59 in EPS. That's giving the company an 8.8x forward P/E -- way too low in my book. Other comparable tech companies trade at double and sometimes triple that.

Originally published in RealMoney.com on 4/22/2009 12:24 PM EDT

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Google's Interest in GeoEye and Geospatial Imagery

A few days ago, I wrote about Google's potential interest in buying geospatial imagery company, GeoEye. Here are some additional reasons for why Google might want to acquire GeoEye and control the actual satellites and additional analytical tools which GeoEye possesses as a supplement to their Google Earth product.

One of the first companies which Google acquired after it went public in 2004 (for an undisclosed sum) was Keyhole -- the foundation piece for Google Earth. As a carry-over from that acquisition, Google has continued to sell its Google Earth imagery to end users for a fee: Google Earth Plus (for a $20 annual subscription) and Google Earth Pro (for a $400 annual subscription).

At first glance, it doesn't seem to make sense for Google to keep such a subscription model in place with its dominant Google AdWords Search model. Yet, Google aspires to make money beyond AdWords. They have continued to invest in a competitive suite of applications as an alternative to Office (called Google Apps). They have done so, because they believe people will save their data and files through Web services in the future (in the cloud) rather than on their PC. If this occurs, Microsoft is tremendously weakened and Google grows.

Google Earth is yet another way for Google to make money. However, it is less a money-maker on its own, rather than a way of driving loyalty and therefore revenues back to Google Search and Google Apps. For Google to keep its Google Earth subscription model in place 4+ years since the Keyhole acquisition suggests it has further plans for this model of selling its high-end earth imagery. It is not a mistake that it has maintained this model.

Consider this also. Google is interested in developing its relationship with Government (the largest customer for satellite imagery). Go to www.google.com/federal for more evidence of this. Google's focus in this niche centers on 3 services: Search, Geospatial Images, and their Google Apps suite of Web services (Gmail vs. Outlook, their own apps vs. Office). (To see an example of a government client that has used Google Earth to improve their efficiency, see this case study on the US Forest Service.) As Google develops their relationships with such a client, it becomes much easier to go back and communicate the benefits of search and Google Apps. Microsoft would have to more heavily invest in its Virtual Earth offering to keep up with Google (or perhaps acquire GeoEye's smaller competitor, DigitalGlobe -- who's revenues at the time it filed its S-1 earlier this year were smaller than GeoEye's).

One government client that Google has great interest in developing a relationship with is the National Geospatial-Intelligence Agency (or NGA). NGA also happens to be GeoEye's largest customer. This coming week, Google is a Gold Sponsor of the NGA's Industry Day. This is a classified conference for US citizens only at which the NGA will lay out their plans for the coming year. (GeoEye is a Silver Patron for the conference.) Google will be continuing to push the benefits of Google Earth and Google Search Appliance (its tool for pulling key information from government clients' own records) at this conference and afterwards. They would not sponsor this conference if they did not see opportunity in this government vertical in the years ahead. (GeoEye's chief competitor, DigitalGlobe, is interestingly not a sponsor at this event.)

Some evidence that the NGA has big plans in the years ahead came out last week when the IT consulting firm NJVC, who works closely with the NGA and is also a Gold Patron at the conference mentioned above, announced that it is expanding its square footage by 33% and hiring 100 new employees in expectation of significant growth in the firm in the coming 4 years. NGA is NJVC's largest customer.

Matt O'Connell, CEO of GeoEye, has also discussed rapid expansion to keep up with planned growth in orders from NGA and other customers now that the new GeoEye-1 satellite was successfully launched last week. GeoEye did $200 million in annual revenues a couple of quarters ago and will certainly exceed that in the coming 2 quarters now that they've successfully launched their newest GeoEye-1 satellite last week. The NGA will continue to be a very important customer to GeoEye.

Google also clearly sees opportunity here in this space. The question for Google is how can it take Google Earth to the next level? This is where GeoEye becomes interesting as an acquisition target. By owning GeoEye, Google would own the proprietary images it captures from its satellites. There would continue to be the need to invest in future satellite launches to stay ahead with the most up-to-date technology but Google certainly has the capital and the interest in space to do this. Owning the satellites also allows Google to develop the tools and unique services which can become integrated into Google Earth but (perhaps more importantly down the road for Google) its Android operating system which it will roll out on future mobile handsets (think highly unique location-based services here).

Google could sit back and just buy images (as Microsoft and Yahoo! do) from GeoEye and DigitalGlobe, letting them take the risk of launching the satellites, but their opportunities to develop proprietary location-based services would diminish (or become easier for Microsoft, Yahoo! and others to copy down the road).

GeoEye is a more compelling potential acquisition target for Google than Digitalglobe for two reasons: (1) it has the newest satellite in space today with the most advanced features and (2) it has a cadre of tools for using the images which their private competitor DigitalGlobe lacks. These tools came, in large part, from the MJ Harden acquisition done last year by GeoEye. More tools, from Google's perspective, means more usage of Google Earth from its clients and therefore more usage of Google Search and Apps.

Additionally, Google and GeoEye have grown closer in these last few weeks. The two companies agreed that GeoEye would not sell its images from GeoEye-1 to any other online portal. Google's co-founders, Larry Page and Sergey Brin, were at the launch of GeoEye-1 in California last Saturday (Page remember has signed up to be launched into space himself in 2011).

Google doesn't buy GeoEye for $200 million a year in revenues. It buys GeoEye to make Google Earth and Android truly remarkable in the years to come, as well as cementing Google's place in the Government vertical with its core Search and Apps offerings.

A deal before the end of the year would make sense as GeoEye is beginning discussions with other parties about funding its next satellite GeoEye-2. Google has the opportunity to control the specs of what that would look like if they do the deal now instead of waiting and having to share the specs with other parties.

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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TheStreet.com: Activist Investor: GeoEye's Seeing Things My Way

08/25/08 - 02:22 PM EDT
From TheStreet.com
By Eric Jackson

My first Activist Investor column for TheStreet.com in March featured GeoEye (GEOY - Cramer's Take - Stockpickr), a satellite company in which I had just started an activist campaign.

This investment is down more than 20% since the start of the year (despite a 50% run-up since mid-July); however, the company's management has been receptive to recent behind-the-scenes activist efforts. GeoEye looks ready to make significant gains in the remainder of this year and into next year after the launch next Thursday of its newest satellite (GeoEye-1).

GeoEye leads the market, in terms of revenue, in operating satellites that capture geospatial images used by government and businesses. Its images are used by such customers as Google Earth, the U.S. Department of Homeland Security as well as agriculture companies, city developers and planners, real estate developers, video-game makers and companies that develop location-based applications. GeoEye offers a whole set of tools and services for customers to package its images (including historical images from its library) and help them analyze and dissect the information.

What first attracted me to small-cap GeoEye was its low valuation. It had a trailing price-to-earnings ratio of 12 in February, despite projections of growing earnings by 20% each year for the next five years. Unfortunately, that figure kept dropping until it was below 6 in early July.
Up until the last couple of quarters, when the company started losing some orders to competitor DigitalGlobe, which currently operates the newest satellite in the sky, GeoEye was generating $200 million in revenue with operating margins in excess of 45%. If you assume a rapid return to these numbers (and likely higher) once GeoEye-1 launches next week, this company's shares can be bought for just above 4 times next year's earnings.

The company's stock price has slumped in the past six months for several reasons. Its planned launch of the GeoEye-1 satellite had been delayed several times and investors have worried it would be delayed again. The successful launch of the satellite is a gate for future earnings potential. Until the launch happens, however, customers will go to GeoEye's competitor, which currently has the best satellite in the sky.

Other uncertainty has weighed on the stock price. GeoEye announced earlier this year that it would need to restate a small part of its previous year's earnings based on advice of its accountants to ensure they had properly accounted for previous net operating loss carry-forwards.

One of GeoEye's greatest problems has been poor communication. Management has done a lousy job outlining its competitive advantages to investors. This poor communication only exacerbated investors' concerns about the GeoEye-1 launch delay and the earnings' restatement.

It got so bad that one analyst, during the first-quarter earnings call, excoriated GeoEye's CEO and CFO for their poor job of communicating. He directly blamed this failure for the company's low P/E ratio.

Positive Signs

But some things have gone on behind the scenes in the past six months that should please investors. First, GeoEye's No. 1 competitor, DigitalGlobe, filed to go public. This meant it had to open its books to the public in an S-1 filing with the Securities and Exchange Commission, a disclosure that revealed it was smaller than GeoEye. DigitalGlobe's decision to go public also allowed Matthew O'Connell and Henry Dubois, GeoEye's CEO and CFO respectively, to speak more freely about their business without fear of giving their private competitor an unfair advantage.

The second thing that has happened is that O'Connell and Dubois have listened to the criticism of shareholders and learned from it. The recent second-quarter earnings call was much improved over previous ones. On the most recent call, held earlier this month, they laid out all the details of the Sept. 4 satellite launch and cleared up what they had recently concluded about their recent restatement in a way that comforted investors. The stock has held its recent gains, instead of dropping precipitously as it did after the first-quarter call.

GeoEye has also been responsive to private criticisms I've directed to management, so I would like to give them public credit for this.

When I launched my activist campaign against GeoEye in the spring, I outlined in a letter to GeoEye's chairman and CEO three important but fixable problems I urged them to correct:

1) raising the company's price-earnings ratio through better investor relations and better communication in general,

2) clearing up the earnings delay immediately, and

3) ensuring management and the board had enough "skin in the game" and adding new board members to strengthen the overall team.

I have spoken to Matt O'Connell and Henry Dubois several times since I sent my first letter. In my view, communication with investors is much improved when it comes to discussing what the company is doing to achieve its immediate-term goal of a successful satellite launch, frequent pitching of the strong GeoEye story through investor meetings. Speeches at investment banking conferences have clearly laid out why GeoEye is significantly ahead of DigitalGlobe and why the market for geospatial images is expected to explode in the years ahead.

On its most recent call, GeoEye specifically mentioned how it's spending much more time talking to investors and telling its story. GeoEye is now covered by four analysts (all with buy ratings) compared to the one analyst it had last quarter. GeoEye has spelled out how its newest satellite will be the industry-leader for the next two years until DigitalGlobe launches its next satellite.

Also, last week, they hired their first chief technology officer, whose job it will be to better communicate the technical advantages of GeoEye's images and how they will play a part in the burgeoning location-based services market. This last point is still what has been missing in the recent GeoEye presentations and speeches.

The earnings restatement has now occurred, and it did not prove significant. Past years' lost earnings should be equaled out by a tax credit awarded later this quarter. There has been no cash impact on the company and the company still has a strong balance sheet to see it through the successful launch of GeoEye-1.

In terms of management and the board improving its makeup, there is still some work to do. O'Connell, Dubois and some others on the management team purchased some stock earlier this spring. I had encouraged them to do so as a sign of confidence in the company. Unfortunately, they only bought about $18,000 each. In my opinion, that's not enough -- especially given the generous executive pay they receive.

The CEO, O'Connell, deserves a pass on this issue, as he came from Wall Street to run GeoEye a number of years ago and had to make a big personal investment in the company. I know he understands the concept of "skin in the game." I wish he would encourage other officers and directors to follow his lead. Management needs to realize that stock options given to them as part of their compensation is "found money," compared to open market stock purchases.

On the issue of improving the board, there are already a number of strong individuals on this board, many with a government background (which makes sense as the government is GeoEye's largest customer and a co-investor in the new satellite). This board still could use some people with more of a commercial background, as that's a growing customer area for GeoEye.

However, when I spoke to O'Connell, I made it clear that I was much more interested in seeing the company tell its story effectively, clearing up any restatement uncertainty and encouraging insiders to buy some more stock than discussing the board composition issue. I believe they've prioritized the criticisms appropriately.

The bottom line is that GeoEye has listened to its critics and taken action to address many of the criticisms. Management needs to go further in some areas, but they deserve credit for what they've done to date. As an investor, I feel much more confident in this company's prospects based on my interactions with management and seeing them make some progress against these weak points.

GeoEye's biggest weak point remains communicating its powerful story to investors. It can't rely on its CTO to explain its competitive advantages to Wall Street. This is the job of the CEO and CFO, and they've only improved from a "C-" to a "C+" on their communication skills in the last three months.

All eyes are now on the Sept. 4 launch of GeoEye-1. The company needs to continue to actively communicate with investors on the day of and the day following the launch. The launch team has a 98% success rate over the last 150 launches. After launch, the company will perform tests to ensure everything is working correctly, and its largest customer, the National Geospatial-Intelligence Agency, will sign off that everything looks good at the end of October. That sign-off will allow the agency to agree to a new service-level agreement with GeoEye to buy images in the quarter ahead. Other customers will likely follow.

The launch should therefore have a large catalyst effect on the stock price. A more reasonable valuation for the stock would be 12 times next year's earnings, or triple its current price. It might take a few quarters to get there, but patience and activism are likely to be rewarded.

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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TheStreet.com: GeoEye Beams a 'Buy' Signal to Investors

The following is a cross-post from TheStreet.com, which appeared today.

Editor's Note: With this column, TheStreet.com is pleased to debut Eric Jackson. Our newest contributor has led online activist campaigns in the past, and will share his latest investment ideas with our audience. As always, let us know what you think.

I built a position in satellite company GeoEye(GEOY - Cramer's Take - Stockpickr) over the last couple of months.

Initially, I wasn't anticipating launching an activist campaign aimed at the company, which provides space-based imagery to government and commercial customers. The stock has gone up 62% in the past year, and GeoEye seemed well positioned to announce a very positive quarter and year-end results, which it did last week.

I was attracted by the stock's incredibly low valuation relative to projected earnings and peer comparisons. Trailing P/E sits at a paltry 12.66, whereas larger competitors Orbital Sciences(ORB - Cramer's Take - Stockpickr) and Trimble Navigation(TRMB - Cramer's Take - Stockpickr) have trailing P/Es of 25 and 29, respectively. What's more, GeoEye is expecting to increase earnings by 20% per year for the next five years.

However, the market was cool to last week's results even though fourth-quarter EBITDA doubled to $15.9 million from $7 million in the previous year and revenue rose to $45 million from $42.2 million a year earlier. Why?

GeoEye has not released full EPS numbers, as it is waiting for the IRS to rule on how to account for an acquisition it made in 2007. The company promised to release complete numbers before filing its 10-K, which is due at the end of March. The delay is not entirely management's fault, as it is waiting on the IRS. However, the company could have anticipated the snag and should have clarified sooner.

Activism is not just for broken companies. It can be equally important for solid but undervalued or overlooked companies. GeoEye is a perfect candidate because it's been overlooked.

Therefore, I recently launched an activist campaign aimed at raising the value of GeoEye, using the tools of the Web. As I emailed a letter to GeoEye's Chairman, Lieutenant General James Abrahamson, and its CEO, Matthew O'Connell, I posted it to my blog, inviting comments and suggestions from other shareholders.

Reaching out to shareholders of Yahoo!(YHOO - Cramer's Take - Stockpickr) and Motorola(MOT - Cramer's Take - Stockpickr) in two campaigns I ran over the past 15 months, using blogs, YouTube videos, wikis, polls and Facebook groups, was particularly helpful in disseminating my message and soliciting suggestions from an army of similarly frustrated shareholders. I hope the same will happen with GeoEye and in future Web-based activist campaigns.

GeoEye is much smaller (with a $500 million market capitalization) and less well-known than Yahoo! or Motorola. Furthermore, I don't believe it requires a major reshuffling of the board or management. This is a solid company.

The stock's price has appreciated 62% over the last year, as the company has delivered operationally for investors and started to be more widely followed by a larger institutional base.
The board and management team have also shown that they can plan ahead and do the right thing for shareholders. Earlier this year, one of GeoEye's two satellites in orbit (the OrbView-3) failed. For most small companies with poor planning, this would have been disastrous. However, GeoEye had appropriate insurance in place. That settlement ($20 million) on the aging satellite ended up being more positive for shareholders than if the failure hadn't happened.

GeoEye's newest satellite (GeoEye 1) is expected to launch in August and provide significant new revenue-enhancing opportunities to the company's existing and future customers.

However, no company or person is perfect. GeoEyes clearly must take steps to properly reward shareholders by fully realizing the inherent value of the company.

Here is a summary of the activist suggestions I raised to GeoEye's Chairman and CEO in my recent letter to them.

Raise GeoEye's P/E ratio to be in line with its peers: At the moment, GeoEye's trailing P/E is only 12.66. Yet, the company has projected to grow its earnings at 20% a year over the coming five years. Competitors sell at trailing P/Es in the mid- to high-20s. If GeoEye sold for a P/E of 20, the result would be a 58% increase in the stock's price to $45.82. If GeoEye were trading at a premium to its peers, which I believe is warranted, of 40, its stock price would appropriately be valued at $62.62.

I believe that the market has failed to see the inherent value in GeoEye because the company has not sufficiently articulated its strategy moving forward. It's not enough to simply estimate to investors when GeoEye 1 will launch or provide timelines for GeoEye 2 (its next-generation satellite that won't be launched until 2011), for that matter.

Investors want to know what the company will provide to its customers better than its competitors and in a sustained fashion. They also want to know that GeoEye is unique and better positioned to deliver to a large and fast-growing market. This hasn't happened as effectively as it could, in my opinion. I believe that, with a much more focused and vigorous explanation of GeoEye's inherent value relative to its peers, the market would properly value the company.

Rectify the earnings delay: Despite strong revenue announced during last week's quarterly call with analysts and investors, the company's stock was immediately punished, falling to $28 from $33. The reason was the management team's inability to communicate GeoEye's 2007 EPS because it couldn't account for net operating losses from the acquisition of M.J. Harden Associates from GE in early 2007.

These days, the markets abhor uncertainty. Investors shoot first and ask questions later, sometimes when it's unwarranted, as is the case here. The current stock price appears to me to be a market overreaction. However, this is partly management's fault for failing to move more swiftly in 2007 to clarify this point. They need to get this information out to the market as soon as possible.

Get a better board with more skin in the game: GeoEye has a prestigious group of directors. Its chairman, Lt. Gen. James Abrahamson, formerly headed up Ronald Reagan's "Star Wars" project. James Simon, former Assistant Director of the CIA, is also a director. However, a disproportionate share of directors on GeoEye's board have government/military backgrounds. There is also a plethora of lawyers and accountants. Such backgrounds aren't objectionable in themselves (the government, after all, accounts for over half of GeoEye's revenue). But it is a concern that there are no directors who represent the perspective of GeoEye's commercial customers.

Additionally, I'm concerned about the low stock-ownership levels of several of the outside directors. In research I collaborated while at Columbia Business School, we found that no single governance characteristic mattered more to improving a company's share performance than the percentage of outside directors on the board who held meaningful equity stakes they had purchased themselves.

The solution to improving the board comes in two forms. First, the board needs to look for possible directors with a commercial background and seek to bring them in as quickly as possible. The Chairman and CEO need to do a full review of GeoEye's current outside directors and their stock ownership.

I do not believe stock holdings are the same as the stock that someone has dug into his or her own pockets and purchased. The two are different as motivators and as predictors of future stock appreciation. There are several GeoEye outside directors whose stock holdings likely have only come through grants and options paid to them for their service -- the equivalent of found money. That's not enough "skin in the game," in my view. I would like to see each of GeoEye's outside directors purchase at least $500,000 in stock within the next six months.

I would not be a shareholder in this company if we didn't believe GeoEye had a bright future. I expect the clarification of GeoEye's earnings before the end of the month will be a major catalyst for the stock. It should be appropriately valued at $45 today. It will be worth much more upon successful launch of GeoEye 1 later in August.

If it takes some activism to help unlock some of this unrealized value, I am happy to oblige.

At the time of publication, Jackson was long GEOY, YHOO and MOT.

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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