Teradata: Great Technology, So-So Business – Teradata Corporation (NYSE:TDC)


Teradata: Great Technology, So-So Business - Teradata Corporation (NYSE:TDC)

Teradata Corporation (TDC) is in the process of transforming its business model from perpetual software licenses with hardware to SaaS. This transformation to software recurring revenue is intended to reinvigorate sales growth which has stalled and is now negative.

I am sure that this is quite frustrating for investors, as other companies in the data management business are experiencing robust sales growth.

Last year, Teradata introduced its latest product, the Teradata Vantage Platform which is meant to address the competition head-on:

By offering customers full integration of their datasets, tools, analytics languages, functions, and engines in one analytical platform, Teradata Vantage reduces customers’ complexity, risk, and costs. Teradata Vantage embraces leading commercial and open source technologies including our market-leading integrated data warehouse engine, and it is available in hybrid environments, on-premises or in the cloud.



(Source: Teradata)

Teradata’s data management solutions hold great promise, at least they should in theory, based on a Gartner report that was released this year on data management solutions for analytics. Teradata comes out on top in all four use cases against eighteen other vendors.

Yet, the company is having difficulty growing its top line.

Part of the problem is with the transformation to SaaS. The recurring revenue is collected over time instead of upfront as with direct sales. This is not unique to Teradata. All companies going through digital transformation experience this phenomenon, and virtually every analyst mistakes this for slowing revenue growth.

Even without the change in revenue collection, growth would be anemic at best. One of the reasons for this is that the management has decided to focus only on “Megadata” companies, the market segment that will pay the most for Teradata’s offerings.

Characteristics of Megadata companies

(Source: Teradata)

This means that sales to companies other than Megadata companies are being ignored as the churn is higher and margins are lower. I also believe that Teradata may be charging too much for its products, given the vendor feedback on Teradata’s value for money in the Gartner report.

In any case, I believe that Teradata’s stock price is quite undervalued, but that is understandable for a company with negative revenue growth. The company has recently hired new executives to jumpstart sales growth. In my opinion, it is best to wait to see some results with the new management in place before jumping on the Teradata bandwagon. There are other companies in data management that are growing leaps and bounds and they may be better investments. For these reasons, I am giving Teradata a neutral rating.

Stock Valuation

I determine stock valuation on a relative basis by comparing sales multiples and sales growth to the company’s peers. I believe that high-growth companies should be more highly valued than slow-growth companies. After all, growth is a prime factor in valuation models such as DCF. Higher future growth results in higher valuation and, therefore, higher EV/sales multiple.

To illustrate this point, I created a scatter plot of enterprise value/forward sales versus estimated YoY sales growth for the 89 stocks in my digital transformation stock universe.

Teradata scatterplot of EV/forward sales estimate versus forward sales growth

(Source: Portfolio123)

The sales multiple in the vertical direction is calculated using the EV and “next year’s sales estimate” mean value based on all analysts from the Portfolio123 database. The estimated YoY sales growth is calculated using “current year’s sales estimate” and “next year’s sales estimate,” also provided by Portfolio123.

As can be seen from this scatter plot, Teradata is significantly below the trendline, suggesting that its forward sales multiple is much lower than its peers, given its estimated future revenue growth rate. My interpretation is that Teradata is quite undervalued relative to the average stock in my digital transformation universe. In cases like this, one can usually point to a reason why a stock is undervalued. For Teradata, investors have abandoned this stock due to negative growth in sales for the last three years.

Company Fundamentals

High-growth companies generally sacrifice profits for growth, and traditional value factors such as P/E ratio are not meaningful. Therefore, I focus on other metrics such as the “Rule of 40%,” free cash flow margin, and cash burn to evaluate software companies.

The Rule Of 40%

The Rule of 40% is a metric used by software companies to help them achieve a balance between growth and profitability. The Rule of 40% is interpreted as follows: If a company’s growth rate, plus profit, adds up to 40% or more, then the company has balanced growth and profit and is financially healthy.

There are several different ways of calculating the Rule of 40%:

Growth – The standard growth metric is to use the Annual Recurring Revenue (ARR) growth rate. For my Rule of 40% calculation, I use percentage sales growth TTM. There are three reasons for this: (1) ARR is not always available, (2) most SaaS companies grow not only organically but also by acquisition, and (3) many companies are in the middle of a transformation to SaaS and have a significant amount of product sales.

Profit – I have seen many variants for the profit metric. Some analysts use EBITDA margin. Others use the operating cash flow margin or free cash flow margin. I use the free cash flow margin, as I believe that is the most meaningful factor from an investor’s perspective.

Revenue Growth

Teradata’s revenue grew by negative 6.4% for the most recent 12 months and has been negative for the last three years.

Teradata historical chart of sales growth

(Source: Portfolio123)

There are several reasons why revenue is decreasing, including the transformation to SaaS, focus on “Megadata” companies at the expense of other less demanding opportunities, and minimization of consulting activities. Instead of using the negative growth figure for the Rule of 40% calculation, I am going to be somewhat generous and use ARR growth which is 11% YoY.

Free Cash Flow Margin

Teradata had a free cash flow margin of 2.7% for the most recent 12-month period. The free cash flow margin has been decreasing steadily since January 2015 when it was a healthy 23%.

Teradata historical chart of free cash flow margin

(Source: Portfolio123)

Rule Of 40% Applied To Teradata

Teradata’s YoY ARR growth was 11%, while free cash flow margin was 2.7%. Therefore:

Revenue Growth + FCF margin = 11% + 2.7% = 13.7%

Because the Rule of 40% calculation comes out much significantly lower than 40%, I conclude that the company has a lot of work to make the company financially healthy and bring growth and profits into balance.

SG&A Expense

As an investor, one wants to make sure that if a company doesn’t score well on the Rule of 40%, it is at least not burning cash. I am happy to say that Teradata is not burning cash, at least not due to SG&A expense.

Note that SG&A includes Sales & Marketing, General & Administrative, and R&D.

Teradata historical chart of SG&A expense to sales

(Source: Portfolio123)

In the case of Teradata, the SG&A expense is 44% of the total revenues which is a reasonable figure and in fact much lower than most SaaS companies. The SG&A expense relative to sales has been rising for a few years but that is because of the transformation and new product development.

Another way to look at cash burn is to create a scatter plot that shows the operating margin/EV versus forward sales growth for SaaS stocks. The operating margin for my purposes is calculated as follows:

Operating Margin = Gross Margin TTM – SG&A Expense Margin TTM

Teradata operating margin / EV versus SG&A expense to sales

(Source: Portfolio123)

Teradata is situated substantially below the trendline, suggesting that the company’s operating margin (gross profit margin – SG&A expense margin) is too low for a company with very little forward sales growth. If forward revenue growth were above 10%, I would consider the operating margin to be acceptable, but not when the forward sales growth is estimated to be less than 3%.

Competition

According to Gartner report Critical Capabilities for Data Management Solutions for Analytics, Teradata is rated the best by customers in four separate data management use cases. Yes, the company was rated 1st against eighteen other vendors in all four categories.

Gartner report rates vendors in four data management use cases

(Source: Gartner)

However, in the same Gartner report, it was stated that:

[Teradata] had the lowest relative survey score in the impression of value for the money spent.

I interpret this statement to mean that the customers surveyed agreed that it was the best technology but was too expensive for their application.

I would be furious if I were a shareholder

I have a problem. How is it that the “best” data management and analysis company can’t grow revenue? Consider how Teradata compares to these newcomers in related fields:

Stock

MktCap

Revenue TTM

Revenue Growth TTM

Application

MongoDB (MDB)

$8.5B

$346M

70.7%

General-purpose database platform

Elastic (ESTC)

$6.8B

$305M

64.8%

Ingest, store, search, analysis, and visualization

Splunk (SPLK)

$16.6B

$2.0B

36.1%

Investigate, monitor, analyze and act on machine data

Domo (DOMO)

$690M

$151M

30.2%

Data collection, processing, and storage

Cloudera (CLDR)

$2.3B

$648M

21% (ARR Growth)

Data management and analytics

Teradata

$3.6B

-6.4%

Data collection and analytics

While most of these companies are not direct competitors of Teradata, they could be if Teradata chose to be in these market niches. These companies are data management vendors, and most are doing extraordinarily well in their target markets.

It is clear to me that something is very, very wrong with Teradata. The company supposedly has the best data management products but can’t grow its sales. I believe it is time for a shakeup at the top. In fact, that is already happening. So far this year:

  • Bob Joyce has been appointed to the new role of EVP, Teradata Business Systems
  • Scott Brown has been appointed as CRO
  • Kathy Cullen-Cote has been appointed as CHRO

It will be some time before we know if these new executives have a tangible influence on Teradata’s Performance. In cases like this, I find that there is usually a “culture” problem at the top, and if the top level is not replaced, then the problem remains regardless of how many other changes are made. We will have to wait and see.

Summary

Teradata is in the process of transforming its business model from hardware sales and perpetual software licenses to SaaS, a move intended to boost revenue. Unfortunately, the opposite is occurring. The company has had negative revenue growth for several years.

Teradata scored exceptionally well in the Gartner report that was released this year on data management solutions for analytics. Teradata came out on top for all four use cases against eighteen other vendors.

While it is clear that Teradata has exceptional technology, it appears that they are having trouble with marketing and sales. This trouble has resulted in new executives entering the scene, including a new CRO. It will take some time before we know if the new kids on the block have a positive effect on company performance. Until then, I give Teradata a neutral rating.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.




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