Teradata – Its Turnaround Journey Just Took A Few Steps Forward
@Teradata – Its Turnaround Journey Just Took A Few Steps Forward Nov. 10, 2017 1:22 PM • TDC Summary Teradata reoported its results late last week. The company’s quarter featured noticeable beats in terms of revenues, and earnings as well as an increased forecast for Q4. The company’s preliminary forecast for 2018 indicated results well above prior consensus levels. While the shares responded positively to the strong quarter, their valuation remains very compressed and does not reflect the potential for future growth. Most third party market researchers continue to rate Teradata’s offerings as the best in its market segment, which itself is large and rapidly growing. Teradata – This quarter there were a few blossoms along with green shoots One of my pet peeves about earnings season is that it is…well a season and lots of companies report in a very short time and investors are compelled to evaluate lots of information without either the time or the details with which to make informed judgements. Investors, on average, have far more interest in the results of a Shopify (SHOP) or Microsoft (MSFT) than they do regarding the results of a little known and not well-respected name such as a Teradata (TDC). And yet, the appreciation potential for TDC shares is likely to be at least as substantial the former two names-just because it is currently little known and less respected as a company. At some level, finding these neglected and disrespected businesses that have been left as road kill by most analysts and investors is how I try to make part of my living. Owning momentum growth names such as Amazon (AMZN) and Facebook (FB) has been a profitable strategy this past year and requires far less effort than attempting to shine some light in a dusty quarter. The QQQ is up by 20% YTD which represents a challenging hurdle for stock pickers. Perhaps of more significance, the IGV tech/software index has risen by 42%, far more than the 18% appreciation of TDC shares over the same time period. Will those trends continue? Will that kind of relative performance persist? I am inclined to doubt either one is likely to be the case over the coming year-although I still hold my Amazon shares. I think it is worth looking at the operational performance of Teradata this past quarter to determine if the gap between its share price performance, and the performance of the IGV index, in particular, has been justified and if it has the potential to achieve better performance on a relative basis in the coming quarters. Needless to say, I think the latter is likely-else I wouldn’t be writing this article and wasting key strokes and electrons. But trying to find undiscovered and unloved corners of the IT firmament has become an increasingly difficult undertaking and one that requires investors to cast their nets further afield. Investors are right to want to invest in the big data/analytics space. It continues to grow at rates substantially greater than IT as a whole and given the breadth of use cases that enterprises have been deploying, that trend seems likely to continue for years to come. But it is not terribly easy to find an investment vehicle that is totally attuned to the space and which is likely to benefit explicitly from the trends in the market. I certainly do not think that companies in the data visualization space such as Tableau (DATA) are really likely to be long-term beneficiaries. Companies riding the #Hadoop wave such as @Hortonworks (HDP) and @Cloudera (OTC:CLDR) continue to grow rapidly, but their path to profitability is long and rocky. And then there is @Teradata, a company that in some ways has been a big data pioneer. The company was poised to do excellent things but simply lost its way under its former CEO who was replaced in a sort of “hail Mary” for the company’s independent survival by Vic Lund about 18 months ago. It has been an interesting journey so far, if not a terribly profitable one for the shares. But the last quarter or two suggest that the opportunities inherent in this company’s technology and its installed base are on the cusp of realization. Advertisement ￼ Reviewing the quarter and the guidance Teradata reported its results for Q3 on last week. The results were better than expectations in terms of reported EPS, revenues and growth of product ARR. Guidance was increased as well because of the strength of the pipeline. Specifically, the company reported revenues of $526 million which was about 3% above the prior consensus with EPS of $0.29, an $.08 beat although some of that was based on the timing of tax obligations (excluding that factor, EPS was $.03 above the prior consensus). In terms of revenue performance, the most important number to consider I believe, was the growth of product ARR which reached 23%. Recurring product revenue increased by 9% sequentially. This trend is not yet visible in the deferred revenue metric as most deferred revenues are still generated by annual maintenance contract billings. The company forecast for its Q4 was increased modestly, by about 1%-2%. The company is seeing a rapid and substantial transition to subscription-based consumption offerings The CFO indicated that the company’s large deal pipeline was significantly skewed with most transactions likely to be based on some kind of subscription pricing. As a result, it is forecasting product ARR growth in the mid 20% range. That is a significant number and suggests that the company has been able to sell an increasing volume of deals with consumption models new to Teradata. The company’s EPS forecast looks like a guide-down but that is a function of the aforementioned timing of tax obligations. At the mid-point, and adjusted for the timing of tax recognition, TDC increased its EPS expectation by $.01. I might point out that Teradata uses a relatively modest level of stock based comp, net of tax provisions, and has no amortization or acquisition related expenses to report either. While logically, this ought to be a factor in evaluating the company’s performance and its valuation, that is not likely to be the case. Investors have their preferences when it comes to such things and the absence of stock based comp simply isn’t valued to any great extent. The company’s transition is weighing noticeably on its P&L which is typical of companies moving their revenues to a subscription model. This company continues to sell some hardware in conjunction with its software offerings so the transition to a ratable model inevitably has and will take a toll on reported gross margins. Last quarter, the company saw its gross margins decline by almost 600 basis points on a GAAP basis, although they increased at a marginal rate sequentially. The company will need to be much further along in its transition to ratable revenue sources before it is likely that it will be able to improve its expense ratios on a consistent basis. Part of the decline in gross margins relates to service performance which saw a decrease of more than 500 basis points, mainly a function of the company’s consulting practice. The company’s consulting practice is also in the midst of a transition which has lead to longer and more complex assignments and stretched revenue recognition. The consulting initiatives are part of the company’s marketing effort and a necessary component of the company’s strategy to reignite growth and to differentiate what it offers. The results of the company’s consulting business in Q3 was a continuation of trends forecast over the past year although the company is now forecasting some improvement in Q4 in this segment in Q4 based on revenue recognition from milestone attainments of larger contracts. The company had a noticeable increase in GAAP operating expense which rose by about 20% year on year. GAAP operating expenses actually fell a bit sequentially but they will remain at elevated levels as a ratio, I imagine, for the foreseeable future. This trend is also a product of the transition of the company to a ratable revenue model coupled with initiatives to broaden the product footprint and to provide users with additional functionality. GAAP research and development cost actually increased by 78% year on year although the sequential increase in research and development spend was just 5%. Selling, general and administrative expense was down by 3% year on year, with the selling component rising and the general and administrative component falling. Teradata, reversing many years of being a closed environment now allows its users to work with their preferred analytic tool and across data sources with the best capability, elasticity and performance for their specific use case. It is probably a bigger deal in terms of appealing to users than it might seem. But these initiatives are taking a toll on reported EPS and while the company will likely improve its optics in 2018, the larger payoff is probably still a few quarters down the road. The company has offered a preliminary outlook for 2018. It expects to return to reported growth in terms of revenues, EPS and free cash flow. The only specific quantitative number that was offered in this guide was product ARR which is expected to grow in the low 20% range. That is actually a number consistent with metrics from companies that are far more highly valued than TDC, but which have much better optics. For investors looking at growth more than optics, low 20% ARR growth is a very healthy number to consider. The company forecast that EPS growth would be more than 10% and as it happens that is a significantly greater increase than the current consensus. The company did not discuss just how much greater than 10% growth it expected for EPS and I suppose that is not terribly surprising. Essentially, TDC has now forecast EPS expectations that will be in the range of $1.40-$1.45 at a minimum, compared to the current published First Call consensus of $1.28. Is Teradata competing successfully in the big data analytics market? Handicapping turnarounds is always a difficult undertaking. There are many things that can and often do go wrong. Teradata has been a tired company with an inflexible and possibly obsolescent set of offerings. The company seemingly lacked vision and was clearly not being effectively run. It can always be difficult to turn that around. Teradata is one of the lowest rated stocks in my coverage universe and presumably those ratings reflect analyst disbelief that a turnaround can be successfully engineered. It is one of the reasons why the company has such major potential share price appreciation. The key is not likely to be this company’s business model or its cost structure. The key is going to be whether this company can retain and solidify its competitive positioning in its space and enjoy the kind of growth commensurate with the expansion of analytic and big data use cases. Teradata’s major competitors at this point include IBM (IBM), Oracle (ORCL), SAP (SAP), SAS Institute and Microsoft (MSFT). AWS (AMZN) offers a solution in the space. I have linked here to the latest Gartner study of competition. As has been the case for many years at this point, Teradata is most highly ranked. I do not necessarily agree with everything that Gartner writes. Still, it might be worthwhile considering some of its commentary about TDC’s competitive positioning: “Teradata has built a DMSA platform that addresses all use cases…Teradata’s ability to integrate with multiple data sources including Hadoop and streaming data, to provide a unified query interface and to deploy in multiple environments such as appliances, software and the cloud, demonstrate its market leadership in product capabilities and a strong vision for the future.” According to Gartner, “Nearly 80% of Teradata’s reference customers consider it to be the standard DMSA (data management solutions for analytics). “Teradata’s reference customer scores for performance across a broad range of use cases, were among the best of all the vendors in this Magic Quadrant.” These days TDC is actually the bargain of the query world. From the CEO script on the last conference call transcript-but not necessarily invalid, nonetheless, “The other guys can’t come close to the cost per query from Teradata. This is the real measure of value of data, how much work can be done in a given amount of time? We ran a benchmark on one million real-world queries, and the cost per query from TDC was less than $60 versus more than $600 for the leading cloud database.” I have no reason to disbelieve the number-although I would like to see Teradata use those kinds of statistics to broadcast its message more effectively. What I can say is that going back for a decade, TDC was considered by analysts and users always the most expensive solution and now it is the cheapest. Eventually users react to those kinds of differences-and to the extent that the 20%-25% growth in product ARR is an indicator, they already are. One of the major issues for Teradata is overcoming user reluctance to adding an additional database to their environments. The company, at least over the past year or so, has attempted to reach out to that concern by making it easier for users to consume Teradata in multiple environments without many constraints. Again, from the CEO script., “Fourth, move anytime. With TDC Everywhere, we’ve revolutionized software license portability so companies can move their software where needed across deployment options. There is no lock-in as with other vendors. This is an enterprise software industry first.” I am not sure if this iteration of license portability is really a first, but it is certainly a marked differentiator compared to TDC’s larger competitors. In some ways, it is a similar strategy to that being adopted by Nutanix (NTNX) which allows its software stack to be used on most hardware platforms depending on user needs. TDC’s most salient competitive disadvantage is that it is specializes in one technology and competes with giant vendors who are able to leverage their incumbent status as a DBMS vendor. Many of the larger vendors have incorporated some of the features necessary to support analytical applications without the need for a specialized database, In some cases that restricts TDC’s potential in a client to the most demanding analytical use cases. That has been a marketing issue since TDC has been a company; it seems likely that the proportion of more demanding analytical use cases has risen as this market segment has shown rapid growth. Teradata has probably never had a better competitive position than is the case currently. It always has had a differentiated database suitable for complex queries. Its advantages in doing that job have seeming been reinforced over the years. It has far more flexible consumption options than its competitors and contrary to its long-held position as selling solutions at a premium, it has become the bargain solution in normal environments. The company’s challenge isn’t technology or competition but to communicate its advantages and to close deals. It isn’t a simple task to reverse negative momentum and this company has to overcome many negative perceptions that were allowed to fester amongst its users and potential customers. But I think it is fair to suggest that TDC should start to achieve market share gains and big deal success. While retuning the organization to enhance sales execution is a something that still has a ways to go, the company is equipped to win against it major rivals. The market for Data Management/Analytics is quite large, with most observers projecting the TAM at over $100 billion including both hardware and software. IDC projects this market to have a CAGR of 12% over the next few years. A competitive TDC, in a market growing at 12%, would readily stand consensus expectations for growth on their head. IDC, in its October report suggests the market size currently is $130 billion. Teradata has substantial growth opportunities in this market-it simply needs to marshall its strengths and execute properly in order to restore double digit growth in revenues and rapid growth in EPS. Needless to say, however, that is not that simple of a task. Valuation Teradata, as was pointed out at the start of this article, has seen chronic underperformance of its shares for several years now and is one of the rare tech companies that is nowhere near a high, selling at less than half the price the shares once fetched. Teradata currently has about 126 million fully diluted shares outstanding and at current market prices, it has a capitalization of $4.4 billion. With net cash of just less than $500 million, the enterprise value of Teradata is $3.9 billion. 2018 sales, as projected by management during the conference call should be around $2.2 billion. That calculates to an EV/S of 1.8X. I think that represents a bargain ratio and one moreover, that doesn’t represent a value trap. TDC is still in the early innings of an earnings turn-around, and the nature of a transition that involves switching the preponderance of revenues from up-front revenue recognition, to a mix of product consumption arrangements that involve multi-year terms, will be one that constrains rapid growth of EPS in its early stages. That said, the company has forecast that its EPS will reach in the range of $1.40-$1.45 next year, which is significantly greater than the current consensus as recorded by First Call. The P/E, based on TDC’s forecast is now 24.6X. In these days of generally elevated valuations, a 25X P/E is a relative bargain, but a bargain only insofar as TDC can continue to nurture its very nascent revenue. growth recovery. Again, the basic theme of the preponderance of the analysts who have rated the shares at hold or sell, is that TDC remains road kill with no plausible scenario that will lead to a lasting growth recovery. I think that is shoddy analysis, that hasn’t chosen to look at the company’s latest developments. At this stage, TDC is not really a cash flow story although it has a relatively substantial free cash flow yield.. Cash flow from operations was negative last quarter and stands at $300 million for the first nine months of 2017. I don’t rate this company a cash flow story because most of its cash flow comes from the decline in receivables which is correlated to some degree to a decline in revenues. In addition, the decline in DSO, which is substantial, is not something that can be a longer term source of CFFO. The change in deferred revenues thus far this year has been negligible, and while it is likely to show a seasonal increase in Q4, at this point, ratable revenue arrangements are not seeing cash collections in advance of revenue recognition. That could possibly change going forward. As mentioned, TDC shares are almost completely unloved with but 2 lonely buy recommendations listed by First Call out of 22 analysts reporting their ratings. I personally think that is a good set-up for investors but not all will agree. At the end of the day, the question is simply will TDC be able to achieve the business goals the CFO laid out during the last call. The CFO (who is taking a medical leave after a long period of battling ill-health) has forecast a return to growth coupled with a strong increase in product ARR. The rating of the shares and the valuation metrics in no way reflect that there is any broad belief that this is a likely scenario. As I have pointed out, the company has better technology, at least in the view of third party market researchers, a very loyal installed base, very flexible terms for buying its solutions and very competitive prices. It is competing in a strongly growing market that should continue to see double digit expansion. It should be successful in achieving, and really over-achieving the objectives laid out by the CFO in what is presumably his swan song. It is hard to know when a turnaround gets recognized. In the case of TDC, while the company has shown some green shoots and a bit more, the recognition that it could be a major contender in its space has simply not yet happened. The company tried to enthuse analysts in its presentations last fall without success. I think that investors looking for a turnaround with substantial potential for positive alpha could do lots worse than consider TDC at this point but some level of patience will be required with owning this name. Disclosure: I am/we are long TDC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.