The Pentagon and the head of U.S. intelligence signed an agreement on Aug. 15 to buy and jointly manage two imagery satellites, a move that last month John Young, Pentagon acquisition chief, warned was inconsistent with a presidential directive to maximize commercial imagery.
The two commercial satellites would cost about $1.7 billion and would be launched around 2012.
According to a Reuters news report, the satellites, launch vehicles and associated ground-based command and control equipment would be purchased by the National Reconnaissance Office, or NRO, using military intelligence funds.
So what does this mean for GeoEye (GEOY) and its only U.S. rival, DigitalGlobe (DGI)?
GeoEye provides space-based and aerial imagery and geospatial information through high-resolution and low-resolution imagery, imagery-derived products and image processing services to customers worldwide. This capability benefits a broad array of industries, including national defense and intelligence, online mapping, state and local governments, environmental monitoring and land use management, oil and gas, utilities, disaster management and insurance.
So how will the government’s entrance into the commercial satellite imagery space impact this already nascent field?
Haven’t We Seen This Before?
Let’s start at the beginning.
In 2005, after many years of bumbling and stumbling, the government canceled a project called the Future Imagery Architecture after indecision over what kind of capabilities it should have, skyrocketing costs, constant delays and general incompetence by the government and their building partners.
The project was canceled even before a single satellite was launched, wasting billions of dollars.
In fact, the primary contractor, Boeing (BA), ran into technical problems developing the satellite and spent nearly $10 billion, blowing its budget by $3 billion to $5 billion before the Pentagon pulled the plug.
The decision to move ahead with the government’s Broad Area Space-Based Imagery Collector, or BASIC, program and build and operate these two government-owned satellites caps months of wrangling between the Air Force, the NRO, the National Intelligence Directors Office and the Office of the Secretary of Defense over whether to buy and operate commercial satellites or to pump the money into buying dramatically more imagery from the commercial companies that already have similar satellites in orbit. such as GeoEye and DigitalGlobe.
A New York Times piece quoted Alden V. Munson Jr., the deputy director of national intelligence for acquisition, as saying: " FIA was a catastrophe ."
However, regarding the current planned project, he said that the BASIC program and the FIA fiasco did not resemble each other at all and that “this project is like going down to the Chevy dealer to buy a Chevy.”
Last I checked, there were no “Chevy” dealers for satellites that cost $500 million to create and take four years, from conception to launch, to procure.
There’s a reason there are only two commercial satellite providers in the U.S.
The business of building, running, and getting the specs just right on something so delicate should be handled by those that already poses that expertise, not by a less-proven and potentially incompetent branch of the U.S. government.
In fact, there is already grumbling taking place as to whether or not the NRO, which was in charge of the last failed satellite project, should again be put in charge of overseeing the purchase of these new satellites, as is now planned.
Further reports indicated that there has been mounting friction between these competing branches over the project, its parameters, its outcomes, and who should run the show.
If there is already this sort of bickering going on, I would argue that things already don’t bode well for the BASIC program's going any better than the FIA did a few years back.
So Now What?
In 2003, President George W. Bush issued a directive to “rely to the maximum practical extent on U.S. commercial remote sensing space capabilities.”
This meant that the government should do what it has been doing since that time in aiding companies such as GeoEye and DigitalGlobe with the buildout, launch and imagery purchases from these companies’ satellites.
In fact, this latest news seems to directly conflict with the president’s national security space policy, which directs the government to buy as much commercial imagery as possible to help the companies withstand competition from subsidized foreign satellite companies.
It seems that government officials want to build their own satellites instead of relying almost entirely on GeoEye or DigitalGlobe for imagery because they wanted to make sure that they were always first in line when trying to collect imagery and that the images collected for intelligence purposes could never be improperly diverted.
According to reports, the government satellites could also be launched with a bigger fuel supply so that their targeting could be adjusted more frequently or they could fly at a lower altitude, producing clearer pictures of small objects on the ground.
“If you have troops in harm’s way and you need images to see if there are hostile forces massing, you don’t want to wait for Google (NASDAQ: GOOG) to get its images before you can find out,” Munson said in the Times article.
But this is all far from a done deal.
In fact, with the close of the year for congress approaching, as well as the approvals that are still needed to initiate this program, which must come from the White House and the Office of Management and Budget, it's more than likely that approval, if granted, wouldn’t even come until the first half of 2009 at the earliest. Even then, work and the commissioning of the satellites wouldn’t get started until the back half of 2009, which would push the launch of these satellites into 2013 under a best-case scenario.
However, what we learned from the FIA fiasco is that when it comes to the government's commissioning and running its own satellites, this is far from certainty.
You want to know the strangest part? Another report stated that the Pentagon may decide to turn over operation of the new satellites to GeoEye and DigitalGlobe!
Huh? So why even build and launch them on your own when you would then turn them over to GeoEye and DigitalGlobe to operate?
Wouldn’t it make much more sense to simply work with the companies that have successfully built and launched these types of satellites for more than a decade and have a proven track record, build the satellites you want, and then simply commission them to be only utilized by the government, while at the same time allowing the company’s other satellites to serve commercial needs?
So what does this mean for GeoEye? For now, not too much.
What’s really mystifying about the BASIC program is that the satellites that are going to be built are not going to be any better than the current crop of satellites that are already in orbit via GeoEye and DigitalGlobe.
For more intensive spy capabilities, the government already owns and operates its own satellite constellation with imagery far superior to what it allows GeoEye and DigitalGlobe to provide and what it intends to provide with these two satellites.
So what’s the point?
Aside from ensuring that the government is first up on the docket to get imagery on a daily basis, which up to this point has not been an issue with GeoEye and its current satellite fleet, this all just seems like a colossal waste of time and money.
And it's almost strange enough to warrant a suspicious eye toward someone trying to get a pet project through the system before the election-year changing of the guard. It's hard, otherwise, to explain why the government would even be trying so hard to get this passed, especially in light of past failures.
In fact, Young, the Pentagon acquisition chief, admitted that these two new satellites would “almost certainly compete” with the planned purchases of commercial imagery from GeoEye and DigitalGlobe.
Officials at GeoEye have stated repeatedly that the satellites that are being considered in this directive are already available today.
This is more so the case now that on Sept. 6, GeoEye launched GeoEye-1, the world’s highest-resolution commercial imaging satellite, with the ability to take images with resolutions of up to 0.41 meters, or 16 inches, panchromatic (black and white) and 1.65 meters, or 64 inches, multispectral (color).
The highest resolution is the equivalent of being able to see home plate on a baseball field from space.
From what I understand, the proposed two new satellites under the BASIC program could be built with a slightly higher resolution at best than GeoEye-1, as well as the satellite being launched next year by DigitalGlobe with similar capabilities.
Bottom Line: Leave Well Enough Alone
I think that it’s obvious from where I stand that the government doesn’t need to launch two of its own satellites to compete with what is already available.
At worst, if the government is really concerned about imagery flow and not getting the imagery it needs in a timely manner, it could simply commission GeoEye and/or DigitalGlobe to build and launch another satellite that would be just for the U.S. government and not for any other commercial purposes.
This would alleviate any potential conflicts of interest and would still allow the government to achieve higher levels of imagery for a much lower cost and be much more efficient at that data collection and processing.
As far as we are concerned as stockholders, even if this program is approved next year and satellites are launched by early 2013, it does not affect our current investment thesis with shares of GeoEye, especially now that GeoEye-1 has successfully launched and is almost ready to start taking usable imagery.
I’ll closely monitor the situation for any changes, but suffice it to say that GeoEye’s management team is in close contact with the government agencies that are behind this proposal and is pleading its case as we speak.
CEO Matt O’Connell, in fact, was in Washington, D.C., last week and has been a part of the process for some time, trying to explain the pitfalls of the proposal as well as how GeoEye could already secure what the government is looking for -- if not with its current constellation of satellites then certainly with any additional satellites that would be commissioned by the government for its own private use.
This news could weigh down shares of GeoEye in the short term but will not have any significant impact on the company’s prospects or our investment thesis for many years to come.
By Chris Fernandez of PeakStocks.com
Posted on Sept. 22, 2008
