WASHINGTON: The commercial imagery company, GeoEye, has made its play to buy competitor DigitalGlobe.

UPDATED: DigitalGlobe Rejects GeoEye Bid (Monday 10 a.m.)

The two companies built and operate satellites that provide unclassified overhead imagery used extensively by allies and the intelligence community. The companies had to act, faced as they are with deep cuts to the amount of imagery the intelligence community plans to buy over the next five years.

GeoEye CEO Matt O’Connell made the announcement in an early morning email to employees, saying that: “we are proposing an acquisition of DigitalGlobe. This is a proactive step to provide increased value to our customers and shareholders.”

GeoEye said in a later statement announcing the purchase that, “The combined company would create the world’s largest fleet of high resolution commercial imagery satellites.”

O’Connell argued in his email to employees that the acquisition will save the government money as well as mean the companies will be able to cut capital expenditures and operating expenses “while better satisfying the needs for all customers, domestic and international.” Addressing the fears of employees, he said that “we foresee a need for a very deep and broad bench of seasoned professionals. In addition, we believe the combination will allow the combined entity to develop new products and services faster. We’ll need a lot of talent to develop those products and take them to market.”

A few days ago we asked for and got a comment from Mike Vickers, the undersecretary of defense for intelligence, about the then-rumored cuts to commercial imagery. He said that:

“Commercial imagery remains an important contributor to our GEOINT capabilities, particularly for foundational data (e.g., mapping, charting and geodesy) and for unclassified shareable imagery. As we went through the FY 13 budget process and worked to align national and defense intelligence with the President’s new defense strategy, we found that commercial imagery was an area where we could slow the rate of program growth, thus freeing up funds to invest in higher national security priorities. Even with the reductions across the FYDP, we will nearly double our area coverage by FY-15 from what we had available in FY 11. A recent joint study by ODNI and OUSD(I) has concluded that this will be more than sufficient to meet our national and homeland security needs.”

I believe Vickers was referring to a study begun at White House urging. The study was led by Roger Mason, associate director for systems and resource analyses in the Office of Director of National Intelligence, and Kevin Meiners, acting deputy undersecretary of intelligence for portfolio, programs and resources.

In the short term, O’Connell said in his email that, “I am delighted to confirm that in the last few days, we have received confirmation from the NGA that the EnhancedView program is fully funded through the remainder of our 2012 contract year.” Given how deeply dependent both imagery companies are on the flow of dollars from the intelligence community, this is, as O’Connell says, “excellent news” for both companies. The satellites both companies have built are not cheap to build and put in orbit, costing in the neighborhood of $500 million each. The capital markets were reluctant to finance such enormous capital-intensive projects without long-term indications of solid cash flow. The EnhancedView contracts appeared to offer that. But with the winding down of the wars in Afghanistan and Iraq, the Director of National Intelligence, Jim Clapper, clearly made the decision that commercial imagery could take the budgetary back seat to the superb high-resolution imagery provided by the National Reconnaissance Office.

When Clapper announced “double digit” intelligence community budget cuts at the October Geoint Conference it became clear within an hour that most of the money was coming out of the National Geospatial Intelligence Agency’s hide. And most of that money was coming out of the commercial imagery purchases. I understand that NGA opposed the cuts to the end and was overruled by Clapper, who, ironically, had been among the earliest and strongest champions of commercial imagery when he led NGA.

In the offer letter sent to his competitor at DigitalGlobe, O’Connell indicated he has already lined up financing for the purchase. He wrote CEO Jeff Tarr that “we are highly confident that financing will not represent an impediment” and wrote that “affiliates of Cerberus Capital Management, L.P., our largest shareholder, are prepared to contribute substantial capital in support of our proposed transaction.”

Given the unique nature of this transaction and the fact that the companies largely depend on one customer — NGA — I would be surprised if the government raised any legal objections to the purchase.

Here are the terms of the deal as outlined in O’Connell’s letter:

“To that end, we propose that GeoEye acquire DigitalGlobe in a friendly transaction whereby DigitalGlobe shareholders would receive $17.00 per share in total consideration. Such consideration will be payable as $8.50 per share in cash and $8.50 in GeoEye stock (DigitalGlobe shareholders would receive 0.3537 shares of GeoEye stock for each share of DigitalGlobe owned). This price represents a 26% premium to DigitalGlobe’s closing share price on May 3, 2012. In addition, our Board of Directors would consider restructuring our proposal to increase the cash consideration up to 100% of the purchase price or, in the alternative, reducing the cash consideration and increasing the stock portion of our offer.”