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Any EnhancedView Cut Could Be Aimed at GeoEye, Not DigitalGlobe

One interesting thing to come out of the DigitalGobe (NYSE: DGI - News) Q4 conference call last night was that the company took a dig at rival GeoEye (Nasdaq: GEOY - News), with CEO Jeffery Tarr saying: "We also understand that in a time of unprecedented budget constraints, the value of commercial imagery is not enough, we also must deliver a superior value proposition and the facts demonstrate exactly that. Today, we deliver to the NGA more imagery than the advertised capacity of our competitors' entire constellation. We are the only provider in the industry with a constellation of three healthy high-resolution satellites. This translates into superior reliability, revisit and delivery timelines. Our ImageLibrary now exceeds 2 billion square kilometers, up 54% in 2011 and is growing at a rate of 2.5 million square kilometers per day. This is critical to mapping and change detection and no other provider of high-resolution imagery comes close, and we are the only commercial provider to offer unique 8-band multispectral capability.

"In addition, we remain on schedule for mid-2014 launch of WorldView-3, which we are self-financing. Like our other satellites, we expect to break new ground in bringing innovative capabilities to market.

"In this evolving budget environment, while not a certainty, our expectation is that decision-making will be influenced by the value realized by our customer for each taxpayer dollar. By any measure, cost per square kilometer, cost per satellite or cost per revisit, DigitalGlobe is the leader by a wide margin. This focus on the customer and delivering superior value extends to our efforts to diversify our revenue base and to our second focus area, profitable customer growth beyond the NGA. When it comes to our capability to provide high-resolution imagery to customers beyond the U.S. government, we are also unrivaled in the aspects of quality that matter most to our customers, including coverage, capacity, currency, revisit and end product accuracy." J.P. Morgan concurred with Tarr's sentiment that DigitalGlobe's ImageLibrary is unmatched, but what really caught our attention were comments from Dougherty analyst Andrea James, who wrote: "Our industry contacts have noted that DGI provides about 80% of the imagery needed by the government, for 62.5% of the SLA contract revenue available, while GEOY makes investments in its infrastructure and prepares to launch its second modern satellite. We believe DGI management was alluding to this phenomenon during its quarterly conference call." (Note that James is the analyst whose estimate of a rumored -40% cut in the EnhancedView budget caused the stocks to take a big drop this year.) This prompted us to look back at GeoEye's Q1 through Q3 conference calls, which revealed that the company has not been meeting its required performance metrics under the SLA agreement, resulting in holdbacks each quarter, including a large $750,000 holdback last quarter. Conversely, DigitalGlobe has only had one tiny holdback ($200,000) since the program began five quarters ago, and none for the past three quarters.

What we'd draw from this information is that, if the government cuts back on the EnhancedView program, there is a very good chance that the cut isn't going to be an even split, and if it becomes a winner-take-all situation, DigitalGlobe is likely going to come out the winner. If the Dougherty information is correct, there is a stark difference between the value that DigitalGlobe is providing the government compared to what GeoEye is.

Meanwhile, with the continued holdbacks for GeoEye, maybe the government believes that the company isn't living up to the contract, and that could be where that -40% rumored cut that Dougherty speculated on is coming from, because GeoEye is only giving the government 20% of the imagery at nearly 40% of the budget.

We view DigitalGlobe's current stock price as one of the biggest valuation disconnects we've seen in the market since the height of the Great Recession in 2008 when we saw a number of stocks trade below the net cash on their balance sheets. The big difference here is that the stock trades well below the value of its satellites. The company sports an enterprise value of about $920 million, while its satellites and related equipment carry about a $1.5 billion value. It costs about $650 million to build a new satellite, which is currently less than DigitalGlobe's market cap.

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