Look Before You Leap into the DGI IPO: Watch out for these 4 Big Risks

by Louis Basenese, Oxford Club Senior Analyst

Jim Cramer’s sounding his obnoxious “Buy! Buy! Buy!” on this week’s Digital Globe (NYSE: DGI) IPO – a provider of high-resolution satellite imagery used for defense and consumer location-based applications (i.e. – Google Maps and Microsoft Virtual Earth).

I’m not saying the DGI IPO lacks the potential to rocket out of the gates. The performance of other recent IPOs – Changyou.com (Nasdaq: CYOU) and Rosetta Stone (NYSE: RST) – suggest underwriters are intentionally under pricing deals to get them out the door. In turn, investors are reaping the rewards. The stocks are up 86.3% and 63.7% from their respective offering prices.

However, you need to look beyond the hype surrounding the DGI IPO and consider the risks that could undermine any investment. Here are a four that immediately jump out at me…

• One big customer. Almost 75% of the company’s sales come from one customer. Even worse, that number’s increasing, up from 57.7% last year. Worse still, there’s no long term agreement in place so this revenue source could, theoretically, dry up overnight.

• Failure to launch. The growth story here hinges on the launch of a third satellite, WorldView-2. But there are no guarantees. Despite a projected 1% failure rate, DGI experienced a launch failure in 2000 and lost another satellite to a power system failure in 1997, four days after launch.

• Sluggish first quarter results. We buy IPOs for growth. And this one looks to be doing the opposite. Results released May 6 show sales and earnings off by 2.4% and 24.7%, respectively.

• Insiders are pulling the “fire” alarm. If the growth story is so great, why the heck are insiders cashing out? And I’m not talking about taking some money off the table. Fourteen firms are selling every last share they own. Where there is smoke there is fire. Be wary.

In the end, the fate of the DGI IPO will likely come down to price. Over pay and you’ll be sitting on serious losses in no time.

That being said, we have a good valuation proxy in GeoEye, Inc. (Nasdaq: GEOY). Based on its price and my conservative estimates, DGI’s not worth more than $25 per share.

Remember, you still need to build in a profit margin (25% is my standard profit goal). So if the risks above don’t scare you away, I still wouldn’t buy DGI for more than $18.75.

Good investing,

Lou Basenese

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