GEOY : Liquidation and update

I have recently liquidated my entire position in GEOY for a 15% gain, shortly after the completion of the NGA certification process. While the certification provides $150 million in annual revenue to GEOY, ensuring that it will be able to cover expenses and removing the risk of bankruptcy, the risk of satellite failure as well as the uncertainty of its profit level still remain. This is mainly because management has refused to provide the numbers associated with its commercial contracts (including its Telespazio, Google and CRISP contracts). On paper, GEOY has a high debt load and extremely lumpy earnings, which tends to discourage institutional ownership of the stock. If management does not provide earnings guidance, then several quarters would have to pass for the market to get a feel for the profitability of the company. This is compounded by the fact that the capital expenditures associated with building GeoEye-2 is still unknown. In the absence of guidance, I can only make a guess about the future profitability of the company. I estimate that the NGA contract will cover operating expenses and interest payments, leaving the revenue from GEOY’s commercial contracts as pure profit. In 2007, GEOY derived $65 million from foreign governments and $15 million from commercial companies. While the successful launch of GeoEye-1 suggests that additional revenue will materialize, I am also worried that both foreign governments and commercial companies will cut back on expenses in the midst of this recession. For the sake of argument, lets say that revenue from non-US government sources rises modestly to $100 million. Applying a discounted cash flow analysis with a discount rate of 10% over GeoEye-1’s useful life of 7-10 years suggests that a PE of 6-10 is appropriate. At $100 million gross profit and $65 million net income after taxes, GEOY would have a fully diluted EPS of around $3, suggesting a fair share price of $18-30. Of course, the preceding analysis is merely a stab in the dark; I simply do not know the future earnings of the company.

In addition, there are short-term issues that may prevent the stock price from rising. GEOY will soon announce its earnings for 2008, which is guaranteed to be bad, since 2008 was a year plagued with problems regarding the launch of GeoEye-1. There is also the matter of the 3.25 million warrants (GEOYW)outstanding on GEOY stock with a $10 strike price which expires in March 2010. Hedging of the warrants account for the majority of GEOY’s current short position, and the low strike price ensures that moderate dilution of existing shareholders will occur in 2010. Covering of the short position is unnecessary since the warrant holders are perfectly hedged, and can exercise their warrants to deliver shares if necessary. Management may be giving a conference call in mid March, during which they may or may not give further guidance on the value of GEOY’s commercial contracts. If the conference call is not forthcoming, or if guidance is not provided, I expect GEOY will sink back below $18, at which point I may rebuild my position. The chance that the stock price will sink is also increased as options expiration date approaches, due to manipulation of the stock price by option traders. Of course, I could be wrong, and management could give a spectacularly good guidance as soon as next week, causing the stock to skyrocket. However, I generally tend to shy away from gambling-type situations and prefer to purchase deeply undervalued stocks, of which there has been no shortage of recently.

Disclosure : I do not have a position in GEOY

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