DigitalGlobe IPO Could Be Boon for GeoEye

5/12/09 - 01:08 PM EDT

GEOY , V , MA , GOOG , MSFT , YHOO

[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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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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RealMoney.com: Take the Long View With GeoEye

From RealMoney.com

By Eric Jackson

12/11/2008 1:59 PM EST

GeoEye (GEOY - commentary - Cramer's Take) operates three geo-spatial satellites that take images of Earth up to a color high-resolution of 0.5m. The company sells these images to governmental and commercial customers. Starting next month, these images will start appearing on Google (GOOG - commentary - Cramer's Take) Maps and Google Earth.

The stock trades at a major discount to its earnings potential next year and should appreciate considerably in the coming months. Yesterday, after the close, GeoEye announced a $144 million contract with its largest customer for 2009; this almost equals its trailing 12 months of revenue.

GeoEye is part of a duopoly in the U.S. with DigitalGlobe (a smaller, private and less well-capitalized competitor). GeoEye had been doing $183 million a year in revenue with 45% operating margins until six months ago, when the company gave up some market share to DigitalGlobe, which launched its newest satellite in the fall. GeoEye's revenue and earnings have recently dropped, as customers opted to use DigitalGlobe's newer satellite. The market has punished GeoEye's shares -- especially during the recent selloff of small caps -- taking the price from a 52-week high of $37.37 in January to below $19 yesterday, near its 52-week low.

A number of events are about to happen in the coming weeks -- beginning with yesterday's new contract news -- that should dramatically reverse the direction of GeoEye's shares.

Recall that the primary reason for GeoEye's stock slide this year was that its nearest competitor launched its latest and greatest satellite. In the geo-spatial imagery industry, higher-resolution images keep improving. GeoEye is now about to leap-frog DigitalGlobe's technology, as it launched GeoEye-1, the newest and most advanced geo-spatial satellite in space, in early September. GeoEye-1 will have the best images in its industry in full color for the next 18 months, until DigitalGlobe puts up its next-generation satellite. However, if DigitalGlobe fails to go public during that time, there is a possibility its launch gets delayed, and that would give GeoEye an even longer advantage.

BCC Research estimates that GeoEye's industry market is increasing from $1.9 billion this year to $3.2 billion by 2012. The key buyers of geo-spatial images are U.S. governmental agencies such as the National Geo-spatial Intelligence Agency (NGA) and Homeland Security. The NGA is GeoEye's largest customer, accounting for half of its revenue last year. The NGA also paid half the $500 million in costs to launch GeoEye-1. The agency is therefore expecting to continue to buy a significant amount of images from GeoEye in the coming years. The NGA's investment came, in part, from a presidential directive for governmental agencies to rely as much as possible on buying services and products from best-in-class companies, as opposed to replicating such services or products internally.

Earlier this fall, the Pentagon floated the idea of building and launching some new geo-spatial satellites of its own to supplement its reliance on GeoEye and DigitalGlobe. This plan was quickly quashed by Congress in November, because of budget concerns. This clears the decks for increased business for both GeoEye and DigitalGlobe in the coming six years.

In yesterday's announcement, GeoEye signed a service-level agreement with NGA, whereby NGA will pay $12.5 million a month up to $144 million in 2009. These payments are for planned purchases of images from GeoEye-1. There might be more. If the payments stay at just that level, they will represent a doubling of GeoEye revenue from NGA compared with 2008.

NGA still needs to certify the quality of the images from GeoEye-1. The images are at a high resolution now, but GeoEye is trying to make them even more finer-grained. This certification is expected to happen on Dec. 15 or slightly thereafter. Once that certification takes place, many other commercial and governmental customers for GeoEye's images will likely begin to strike their own deals and purchase the images.

GeoEye's trailing price-to-earnings ratio yesterday was below 9. Its forward P/E, assuming it does $250 million in revenue next year with 45% operating margins, is 3. Other satellite and space/defense companies trade currently at forward P/Es of 7 to 21.

The key reason why the stock has been at depressed levels since the launch is that it wasn't yet clear that the satellite was operating properly. Yesterday's announcement suggests that NGA is ready to spend money on the new images from the satellite once it certifies the images. NGA's planned spending next year almost equals GeoEye's 2007 total revenue of $183 million, after which the stock hit its all-time high of $37.37. That stock price was achieved prior to worries about delays in the launch of GeoEye-1 that depressed the stock.

The table has now been set for significant revenue and operating margins to accrue to GeoEye over the next 18 months, as NGA, Google and other commercial and governmental customers purchase these images. It is highly unlikely that a technical flaw will crop up this long after the launch. The customers who buy these images (e.g., governmental agencies and Google) are also much less affected by the broader economic malaise compared with most companies operating today.

Assuming GeoEye can double its sales and earnings by the end of next year and is rewarded with an increased price-to-earnings multiple more comparable to its related peers, I believe it could trade up to between $60 and $80 by early 2010, up from its current price of $19.

Days before GeoEye launched GeoEye-1, the company announced a relationship with Google. GeoEye would provide its images from GeoEye-1 to no other online portal except Google. Google is not under any restrictions, meaning it could still buy images from DigitalGlobe. No financial details about the agreement between GeoEye and Google have been released. The first hint of what those details might be won't come until early February, when GeoEye holds its fourth-quarter analysts' call.

However, here is what we do know about the relationship and about Google's interest in space:

• Google's co-founders (Sergey Brin and Larry Page) attended the September launch of GeoEye-1.
• Google's logo was on the side of the rocket that launched GeoEye-1.
  Google will begin using images from GeoEye-1 on Google Maps and Google Earth in January and start paying GeoEye for them.
• GeoEye recently paid Google to get its help in improving their search tools so that GeoEye customers could more easily search GeoEye's inventory of images. (DigitalGlobe has no comparable search tools to offer its customers.)
• Google's first acquisition post-IPO was for a small company called Keyhole, which is now the basis for Google Earth.
• Larry Page has signed up to be launched into space himself in 2011.
• Google has recently been investing in building up its relationships with the federal government, to which it sells its Search, Apps and Earth products. Recently, Google was a Gold Sponsor of an NGA Industry Day, of which GeoEye was also a sponsor and DigitalGlobe wasn't.
• Google received special permission from NASA to land its corporate jets at Moffat Field near its Mountain View, Calif., headquarters.

It's difficult to say what this adds up to in terms of a long-term relationship between GeoEye and Google. It's quite possible that Google would look to acquire GeoEye in the future to control the images and search tools from GeoEye and develop a deeper relationship with the NGA and the federal government. And Google could be interested in the possibility of designing proprietary search-imagery applications to use within Search and Android (its mobile operating system used in Google's G1 mobile phone). Google is deeply interested in space and space-based imagery. What is clear is that the market is assigning no value to GeoEye from its ongoing revenue relationship with Google or the possibility that Google might acquire the company in the future.

When GeoEye-1 was launched in September, the company said that the NGA should certify the satellite's operation and sign off on a service-level agreement (outlining its planned imagery purchases from GeoEye) within 60 to 90 days. The service-level agreement with NGA was signed on Tuesday, and certification is expected within the week. Expect new customer announcements to trickle out, now that NGA has gone first. In February, GeoEye will hold its next analysts' call, at which time it should start to shed light on its revenue ramp-up with the GeoEye-1 satellite and on the expected revenue from the Google relationship.

Four remaining risks could negatively affect the stock:

• The satellite could suffer a technical error whereby it becomes inoperable. This is highly unlikely at this point but possible. A major malfunction would slash the company's future earnings dramatically. GeoEye has insurance for this scenario, but it would still not prevent a sharp drop in the stock price. This possibility always exists for the lifetime of every satellite.
  
• Management offers poor communication. I have been an activist investor in GeoEye since March. Its CEO and management team have done a poor job in managing the Street's expectations and communicating the GeoEye story. This still remains a problem area, despite criticism from me and from other investors. Management needs to win over the trust of institutional investors and hedge funds to see its price-to-earnings multiple increase.
  
• The company has had delays in filling the CFO position. In yesterday's announcement about its new contract with NGA, GeoEye disclosed that its current CFO would be leaving. There are many possible reasons for this, and I don't take it as a sign of problems. The company restated its financial statements recently. The board could have decided to make a change. What is important is that GeoEye hire a first-class CFO to fill the role before the next analysts' call in February.
  
• DigitalGlobe could move up the launch of its next-generation satellite sooner than 18 months from now. This is almost impossible. In fact, it's more likely that DigitalGlobe will delay their launch, given that it is waiting to go public to raise needed capital, and the IPO window appears to be shut for the foreseeable future.

In GeoEye, you are getting a world-class leader in a growing and recession-proof industry. Its stock has the chance to triple or even quadruple in the next 15 months. What's more, you're getting a call option on a potential buyout by its partner Google. Put it together, and you have a compelling entry-point at these levels.

[Eric Jackson's fund holds a long position in GEOY.]

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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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