Proposed cuts to NGA’S EnhancedView Program revive the commercial imagery debate
Joshua Hartman recalls the debates that led up to the adoption of an integrated commercial and national intelligence satellite strategy, also known as “2+2,” as nothing short of religious.
“And I mean it in the truest sense of religion,” said Hartman, who served as a senior advisor to the Office of the Under Secretary of Defense for Acquisition, Technology and Logistics from 2007 to 2009. “There were advocates of commercial imagery who enjoyed the value they got from it and thought it hadn’t been given as much exposure as it should have been, meaning its application had been limited so far. They were pushing to expand it as much as possible.”
Meanwhile, advocates from the classified world had been building satellite systems for decades, and felt the government should continue investing in National Technical Means (NTM) for the best interest of national security. They argued that although commercial imagery is more cost-effective, there are certain requirements in the area of resolution only NTM can ever tackle.
Kevin O’Connell, president and CEO of Innovative Analytics & Training, as well as a seasoned national security and intelligence analyst, believes the narrative surrounding commercial imagery has been incorrect for a long time.
“We keep posing these as competitors to the national system,” he said. “They are not and never were intended that way.”
When the “2+2” strategy—a sort of compromise—was announced in 2009, it was determined that the National Reconnaissance Office (NRO) would continue to develop and build classified satellites, while the Department of Defense (DoD) and Intelligence Community would increase use of imagery available through U.S. commercial providers. The strategy was thought to end the commercial imagery debate once and for all.
But the discussion is alive once again with proposed cuts to the National Geospatial-Intelligence Agency’s (NGA) EnhancedView program. So what’s at stake this time around? In one camp sits leaders in the defense and intelligence communities tasked with bowing to unprecedented budget cuts, while still striving to keep the country safe. In the other camp sits the U.S. commercial remote sensing industry, with growing concerns about the fate of their companies, their credibility on Wall Street, and the potential damage to innovation and the industrial base.
To meet the commercial component of “2+2,” the 10-year, $7.3 billion EnhancedView program was awarded in 2010 through a public-private partnership with NGA and the two major U.S. commercial imagery providers, GeoEye and DigitalGlobe. The purpose of EnhancedView is to provide timely, high-resolution, wide-area imagery to NGA, as well as to the overall Intelligence Community, DoD, federal agencies, and U.S. allies. With a 10-year commitment from the federal government, GeoEye and DigitalGlobe each moved forward with plans to build new satellites to meet NGA requirements, courted Wall Street investors, and collectively raised more than $1 billion in capital.
Now, with both companies midway through satellite builds, the austere budget environment has forced the government to re-evaluate the 10-year contract. In a document titled “Defense and Budget Priorities,” released Jan. 26 as a preview to President Obama’s defense budget request for FY 2013, commercial imagery is listed among many programs at risk for cuts as the DoD aims to reduce its spending by $259 billion over the next five years. Although the NGA budget and therefore the proposed EnhancedView cut are classified, some analysts predict the program could suffer a cut as deep as 50 percent.
At press time, the once amicable competition between GeoEye and DigitalGlobe reached a stalemate, each having offered and rejected a takeover of the other in the wake of impending cuts.
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On the Offensive
Although it’s still too early to know to what extent EnhancedView will be cut or where the bulk of the cut will land, both GeoEye and DigitalGlobe have launched an offensive strategy. The continued viability of their companies is at stake in this existential situation.
On May 4, GeoEye made a public offering to purchase DigitalGlobe for approximately $792 million, or $17 per share−$8.50 in cash and $8.50 in GeoEye stock. Matt O’Connell, president and CEO of GeoEye, said a combined company, which would create the world’s largest fleet of high-resolution commercial imagery satellites, stands to deliver exceptional value to the nation, while still benefiting the taxpayer and allowing the government to reduce funding. However, during an investor call following the announcement, Matt O’Connell maintained that the proposal wasn’t based on a specific level of budget cuts in any particular year, and instead focused on synergies between the two companies.
“It’s not that we see something near-term,” Matt O’Connell said during the investor call. “It’s that if you put these two constellations together, you have a world-class team and can rationalize the number of satellites that you build over the mid- to long-term.”
DigitalGlobe promptly rejected what it called a “hostile” proposal May 6, describing it as substantially undervaluing its company. According to a DigitalGlobe press release, GeoEye had made previous unsolicited proposals beginning February 7.
DigitalGlobe said it had also previously proposed to purchase GeoEye, in a transaction under which DigitalGlobe stockholders would own approximately 60 percent of the company, while GeoEye stockholders would own approximately 40 percent. DigitalGlobe said it terminated such discussions with the belief that “the U.S. government process would be favorable” to DigitalGlobe, and that such discussions may distract the government in its decision-making.
Walter Scott, founder of DigitalGlobe and now the company’s chief technology officer, spoke with trajectory via phone a few weeks prior to GeoEye’s May 4 proposal. Scott said if EnhancedView cuts are based on who provides the best value, he is confident the outcome will be in his company’s favor.
“We’re providing north of three-quarters of the high-resolution imagery globally,” Scott said. “The amount of money the U.S. government is spending with both companies is roughly the same. So, you can do the calculations and figure out the rough value there.”
DigitalGlobe said it countered GeoEye’s May 4 proposal with the same 60/40 offer, which GeoEye again rejected. The May 6 release stated DigitalGlobe plans to once again halt discussions and await the government’s budget decision.
Matt O’Connell, who also has years of experience in Wall Street finance, spoke with trajectory in person a few weeks prior to GeoEye’s May 4 proposal. He compared the amount of capital both companies have leveraged on EnhancedView to a mortgage, meaning that regardless of what happens to the program, the company will still have to create a return for its investors.
According to a former senior DoD official who declined to be named, EnhancedView is no different from any other large contract that gets modified or cancelled as a result of changing circumstances.
“These are publicly traded companies that made corporate decisions to pursue the program,” the former official said. “There were great financial rewards to be accrued for the companies and their investors over the lifetime of the program had it gone forward as planned, but that was not without risk. Now, that risk has come to the fore and has, predictably, had a direct impact on stock prices. But there are no guarantees in government contracting, and for anyone to suggest that in this particular case there were unique assurances is naïve at best, and disingenuous at worst.”
Matt O’Connell also pointed to the risk of international companies swooping in on one of the publicly traded U.S. companies, and referenced recent rumors that Paris-based Astrium is interested in doing so.
“The two companies’ [GeoEye and DigitalGlobe] stocks have traded down to the point where we are both valued at the depreciated value of our last satellites,” he said. “At that price, it’s probably cheaper for the French to come in and buy one of us than to buy one of their own satellites.”
An Uncertain Future
Although the scenario Matt O’Connell outlines is hypothetical, it does paint an alarming picture of what could happen to the country’s global advantage if commercial imagery goes by the wayside.
In November 2011, Kevin O’Connell and Bob Weber, also of Innovative Analytics & Training, released “Alternative Futures: United States Commercial Satellite Imagery in 2020,” which Kevin O’Connell describes as the best public rendering to date of the policy and regulatory regime on commercial imagery.
The white paper, which was sponsored by the Department of Commerce and submitted to the government for review prior to release, outlines three possible futures for U.S. commercial imagery in the year 2020.
In the first possible future, U.S. commercial imagery relies on a steady stream of government funding, as well as increased sales to commercial customers, and is a thriving business. In the second future, U.S. commercial imagery providers continue to rely on government funds, which have increased only marginally, and are forced to look outward for additional clients. The third future portrays the industry as a business failure following a sharp downturn in federal funding.
Kevin O’Connell said while he doesn’t attempt to make predictions from his own study, he has briefed and discussed it far and wide among stakeholders in government and industry.
“Most people think we’re going down path two or three, or some variation thereof,” he said.
ITT Exelis Geospatial Systems, a subcontractor on the EnhancedView contract, recently delivered the imaging payload for GeoEye-2, and is now in the process of building the imaging payload for WorldView-3, according to Kyle Schmackpfeffer, director of Commercial Optical Sensing Systems. Schmackpfeffer said ITT Exelis is concerned about the impact cuts to commercial imagery would have for suppliers at their tier and below.
“It would have an impact on our business,” Schmackpfeffer said. “Those customers’ revenue and cash flow will be impacted and their projections of need for future capability will go down. What they would potentially seek to do is get more out of the assets they currently have flying.”
These concerns have not gone unrecognized, and are now being explored through government-mandated and independent studies. At press time, NGA was digesting the results of a classified commercial imagery study conducted by the Office of the Director of National Intelligence (ODNI) and the Office of the Under Secretary of Defense for Intelligence (USD(I)). The study, mandated by the White House Office of Management and Budget (OMB), is intended to measure the contributions of commercial imagery against stated requirements. Additional studies were also under way at press time in an attempt to understand what the true impact of commercial imagery cuts would be to the industrial base.
Cutting a 10-year service-level agreement only two years in may also have some broader unintended consequences, such as damaging the government’s future potential to leverage public-private partnerships.
Matt O’Connell said the situation is confusing to him from a financial standpoint.
“It’s clear there is going to be less public capital available in America,” he said. “The government has to cut back. As public capital is declining, the needs don’t decline. Private capital becomes more necessary.”
He continued that EnhancedView has been regarded worldwide as a great example of a public-private partnership, and that one of the largest private equity funds on Wall Street has invested heavily in GeoEye.
“And now they’re looking at this saying, ‘Wow, maybe we shouldn’t invest in any more public-private partnerships with the U.S. government,'” Matt O’Connell said.
A Balanced Approach
It’s easy to see why commercial imagery has become an easy target for budget cuts, with funding that has grown exponentially throughout the last decade. Budget cuts are expected to hit hard across the entire spectrum of defense and intelligence, not just EnhancedView. But to an extent, Hartman believes a balanced approach to the EnhancedView cuts is feasible.
“When we built the [EnhancedView] budget we didn’t do a very good cost estimate on what our requirements were,” Hartman said. “We just threw a bunch of money at the problem, and we need to really understand what the true requirements for commercial imagery are. It doesn’t mean that we get rid of the EnhancedView contract. It means that we cut things.”
Hartman said in his opinion, a 15 to 20 percent cut to the overall contract would be warranted to better reflect true requirements, but predicts the actual number will land somewhere around 25 to 30 percent.
“It is fair to say that all programs within the U.S. government are being reviewed,” said Karen Finn, an NGA spokeswoman. “NGA is a supporter of commercial imagery because it contributes heavily to our geospatial work in so many ways and it is very useful because it gives us the ability to share it with our domestic and international partners when needed.”
According to Lt. Col. Jim Gregory, a DoD spokesman who provided a statement on behalf of ODNI and USD(I), FY 2013 budget submissions by the DoD and Intelligence Community include efficiencies to save taxpayers hundreds of millions of dollars over the next five years, while still increasing the capacity and quality of the government’s access to commercial imagery. He added that the joint ODNI/USD(I) study is intended to assess the mission, budget, and industrial base impacts of the proposed EnhancedView cuts.
“Commercial imagery has been and will continue to be important and valued in support of national security and U.S. government missions,” Gregory said via email.
He added, “We remain committed to ensuring the health and stability of our space industrial base.”
But concern for the industrial base is growing in Congress. In November 2011, eight members of Congress sent a letter to Secretary of Defense Leon Panetta and Director of National Intelligence James Clapper, expressing their support for EnhancedView.
“We seek your support to ensure that the Department and Intelligence Community confront this difficult decision in a balanced and objective manner and ensure that the capability needed in the future is not irreparably lost,” the letter states.
Rep. Mike Rogers, R-Mich., chairman of the House Permanent Select Committee on Intelligence, said he recognizes commercial imagery as an important and cost-effective imaging architecture that will continue to play a role in national security.
“As part of its review of the President’s budget request, the Committee is analyzing the potential impact the proposed cuts would have on U.S. intelligence activities,” Rogers said via email. “Additionally, we are looking into the impact the cuts would have on the U.S. commercial imagery industry. The Committee will take these impacts into account in formulating its position on the cuts in the annual intelligence authorization bill.”
Can Austerity Foster Innovation?
Sen. Mark Udall, D-Colo., said he is “deeply concerned” about what he described as a “very large” proposed cut to commercial imagery in the FY 2013 budget, especially since the cut was proposed prior to the completion of the OMB-directed study.
This has been a common complaint from many in support of EnhancedView−given that so many studies led up to the adoption of the “2+2” strategy, but none were conducted prior to the proposed cuts.
Other industry experts and analysts point to the inconsistency of the proposed cuts with President Obama’s National Space Policy, released in June 2010, which states that the government will “use commercial space products and services in fulfilling governmental needs, invest in new and advanced technologies and concepts, and use a broad array of partnerships to promote innovation.”
Udall said via email, “It is my understanding that current U.S. policy is to take actions to maintain the leadership and competitiveness of U.S. commercial imagery providers. So, if this administration is veering from that policy, I want to understand why.”
Kevin O’Connell said he sees an opportunity in this constrained budget environment to take new approaches to innovation and space policy. In order for the government to take maximum advantage of industrial innovation, he said, it needs to do a better job of asking for innovative products and services. Kevin O’Connell views these trying budgetary times as an opportunity for the government to consider its entire space architecture, as well as relationships between national security, civilian, and commercial space systems.
“We have two companies that look a lot like the NRO,” Kevin O’Connell said. “The government is creating the wrong incentives in the market and does not have a true commercial strategy.”
For example, he said, the NRO, NASA, and NOAA all have synergies, but the conversations that currently take place between the organizations aren’t enough.
“The budgetary downturn could be the time for the big idea in how to manage space differently,” Kevin O’Connell offered. “If politicians and decision makers chose to go that way.”
The debate surrounding commercial imagery has been raging on and off in Washington throughout the past decade. Although the “2+2” strategy allegedly solved this controversy, here it is again. It has always been, and will continue to be, a wild ride. This problem, how best to utilize and fund U.S. commercial imagery, isn’t likely to be solved in 2012. The economic ramifications are significant, but the national security implications are far more serious.
Featured image: Commercial satellite imagery has proven crucial in times of crisis for disaster relief efforts, from the aftermath of Hurricane Katrina to the recent tsunami in Japan. (Photo credit: DigitalGlobe)