TEXT-S&P affirms DigitalGlobe 'BB' ratings
Overview -- We expect DigitalGlobe to continue to benefit from revenues from its service-level agreement with a U.S. government agency, and from an increased presence in commercial imagery processing and analytic services through its proposed acquisition of GeoEye. -- We are affirming our 'BB' corporate credit rating on DigitalGlobe and removing these ratings from CreditWatch with negative implications. -- Our ratings outlook is negative, which incorporates the expected heightened leverage associated with the acquisition of GeoEye, and possible integration risks, which could keep leverage high through 2014 if expected cost savings from the merger are not fully realized. Rating Action On Aug. 10, 2012, Standard & Poor's Ratings Services affirmed its 'BB' corporate credit rating and 'BB+' issue-level ratings on Longmont, Colo.-based DigitalGlobe Inc. At the same time, we removed those ratings from CreditWatch, where they were placed with negative implications on July 24, 2012. The rating outlook is negative. Rationale The affirmation reflects our view that the business risk benefits of DigitalGlobe's proposed acquisition of competitor GeoEye offset the effect of higher leverage associated with the proposed combination. We believe DigitalGlobe will continue to benefit from revenues from its EnhancedView service-level agreement (SLA) with the National Geospatial-Intelligence Agency (NGA), an arm of the U.S. government. Given the likelihood that the U.S. government will substantially reduce or eliminate its EnhancedView SLA with GeoEye, we believe it is less likely that the U.S. government will pursue further budget cuts that would affect DigitalGlobe's EnhancedView SLA over the next few years. As the potential sole provider of high-resolution commercial satellite imagery services for various agencies within the U.S. government, we believe DigitalGlobe is well positioned to retain its full share of expected revenues from the EnhancedView SLA. At the same time, the ratings recognize that government contracts are not guaranteed until Congress appropriates the funds and that, although unlikely, government agencies may terminate or suspend their contracts at any time. Pro forma for the GeoEye transaction, about half of DigitalGlobe's revenue will come from customers within the U.S. government, and we factor this customer concentration into our "fair" business risk assessment. In acquiring GeoEye, DigitalGlobe would gain a stronger foothold in image processing and analytic services, which could help to drive ancillary revenue growth in future years, particularly in the commercial and international segments. DigitalGlobe currently has a relatively weak presence in the advanced imagery processing and analytics segments, and the combination with GeoEye provides the company with a full suite of imagery services that it can provide to existing and potential customers. The acquisition of GeoEye is subject to various regulatory approvals, but our base-case scenario envisions the transaction being completed in early 2013. The GeoEye acquisition provides DigitalGlobe with significant scale benefits in the form of operational cost synergies and reduced capital spending to manage a combined three-satellite constellation system. We recognize the potential integration risks in realizing these synergies, which could keep leverage high through 2014 if expected savings do not materialize, and we incorporate this risk into our negative rating outlook. DigitalGlobe's "aggressive" financial risk profile is based on our view that total debt to EBITDA, including our adjustment for operating leases, will rise above 4x in 2013 and funds from operations (FFO) to total debt will decline below 20% in 2013, due to the acquisition of GeoEye. In 2014, our ratings assume that credit metrics will improve to near pre-acquisition levels, with debt to EBITDA in the low-3x area, and FFO to total debt in the mid-20% area. Our base-case scenario also includes the following specific assumptions: -- Revenue grows in the low-double-digit percentage area prior to completion of the acquisition, primarily due to strong demand for services in its commercial and international segments. -- In 2013, the GeoEye acquisition closes, and the EnhancedView SLA with GeoEye is not renewed. We expect organic revenue to grow in the high-single-digit range for both 2013 and 2014. -- EBITDA grows from around $160 million in 2012 to around $250 million in 2013, mainly due to the acquisition, with EBITDA margins decreasing from the mid-40% area to the high-30% range, to account for the loss of GeoEye EnhancedView SLA revenues, and the high operating leverage inherent in the satellite imagery business. -- In 2014, we expect EBITDA of approximately $320 million due to the expected realization of cost savings from the GeoEye acquisition, organic revenue growth, and a further increase in recognizable revenue related to DigitalGlobe's SLA. -- Free operating cash flow (FOCF) remains negative in 2012 and 2013, as a result of capital expenditures required for the completion of the WorldView-3 and GeoEye-2 satellites. We expect the company to generate a moderate level of FOCF in 2014 as a result of EBITDA growth and lower capital spending requirements. On Aug. 6, 2010, the NGA awarded DigitalGlobe a $3.55 billion award under its 10-year EnhancedView commercial imagery contract. Under the service-level agreement (SLA) portion of this contact, the NGA is contractually committed to make $250 million of imagery purchases per year for the first four years and $300 million per year for the final six years. In exchange, DigitalGlobe must make a substantial portion of its satellites' image-taking capacities available to the NGA. The company expects commercial customers, other U.S. government agencies, and non-U.S. governmental entities to take up the remaining capacity. DigitalGlobe's business plan greatly depends on its contract with the NGA, a U.S. government entity which purchases earth imagery content from commercial providers on behalf of other agencies within the U.S. government, including the Departments of Defense (DoD), State, and Homeland Security; the Central Intelligence Agency; and the Defense Intelligence Agency. Revenues from the NGA SLA constituted approximately 48% of DigitalGlobe's consolidated revenues in the second quarter of 2012. DigitalGlobe currently operates three satellites: QuickBird, WorldView-1, and WorldView-2. In addition, it is building a new satellite, WorldView-3, which it expects would be ready for launch in 2014. DigitalGlobe is acquiring the GeoEye-1 and GeoEye-2 satellites, with the latter expected to be ready for launch in 2013. Historically, the on-orbit failure rate for the satellite industry is about 5%, while rocket launches fail about 10% of the time. Debtholders are provided some protection from satellite failure, as DigitalGlobe currently maintains insurance on all its satellites. Liquidity We view DigitalGlobe's liquidity as "adequate" under our criteria. Sources of liquidity are likely to be at least 1.5x uses over the next 12 months. Further, we believe that DigitalGlobe could experience an unanticipated EBITDA decline of at least 20% and maintain sources of liquidity adequate to cover uses. At June 30, 2012, sources included a cash balance of over $210 mullion, and expected FFO of about $150 million during 2012. Uses of liquidity primarily consist of capital spending of about $200 million in 2012 for the WorldView-3 satellite and maintenance of existing infrastructure. We expect that the company's financial maintenance covenants under its revolving credit will provide at least 15% of ongoing EBITDA cushion. Our liquidity assessment incorporates the GeoEye acquisition at the beginning of 2013, when it plans to refinance the debt of both companies. Recovery analysis For the recovery rating analysis, see Standard & Poor's recovery report on DigitalGlobe, published on RatingsDirect on Sept. 26, 2011. Outlook The outlook is negative, which reflects the expected heightened leverage associated with the acquisition of GeoEye, and possible integration risks, which could keep leverage elevated through 2014 if expected synergies do not materialize from the business combination. Given the significant customer concentration from the U.S. government at around 50% of the combined companies' revenues, it is unlikely that we would raise the rating unless revenues become more diversified, and FFO to debt rose above 35% on a sustained basis. Conversely, we could lower the rating if FFO to debt were to remain under 20% or if leverage were to remain above 4x on a sustained basis. As the transaction moves toward closing, we will continue to monitor regulatory approval hurdles for the GeoEye acquisition, but we do not expect these approvals to pose a threat to the closing of the transaction. 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Senior Secured BB+ BB+/Watch Neg Recovery Rating 2 2 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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