Restarting a cold engine on a very cold day!
It can be interesting in writing about a star one day and a goat the next. Yesterday, I had the opportunity to compose an article regarding Amazon's (NASDAQ:AMZN) performance. Based on a significant number of commentaries I received, I wasn't able to touch on all of the hot buttons of readers and to tell them how many wonderful things Amazon had done and would be doing.
And now today, I find myself composing an article that looks at one of the doggier companies that has existed in the enterprise IT space - and part of its dogginess has been its inability to choose to work with Amazon until right now in terms of integrating that company's platform with the Teradata (NYSE:TDC) applications.
I wrote an article several months ago regarding the possible light at the end of the TDC tunnel. Some of the things that I wanted to see have now happened. Today, I heard the new CEO and a couple of his staff talk about the transformation this company is seeking to effect. Will they restart the engine in the current environment? Yes, I think they have better than a 50% chance of bringing it off, but it will not be immediate and there will be some pitfalls and speed bumps to negotiate. But investors looking at a decent value name in the Big Data/Analytics space could do worse than look at this one - although to be sure there isn't much else to find in the Big Data/Analytics space that has revenues and profits
The shares have appreciated somewhat this morning in the wake of the earnings announcement. But there was no guidance raise here - in fact, since Q2 was a beat and the full-year guidance is flat, there are some who might say that guidance was trimmed for the second half of the year. Overall, the shares are up about 20% since the post Brexit lows compared to a change in the IGV of 9% over that same period. Since I wrote my first piece regarding TDC opportunities back in early February, the shares have appreciated 27% compared to the 30% appreciation of the IGV. So, thus far, since early February, there has been no positive alpha.
While earnings estimates have crept up by 2-3% over the past quarter, no one is forecasting any revenue growth from their 2016 estimates. The shares are rated just below hold in the First Call consensus with price targets on average being 10% less than the current price of the shares. That, in and of itself, is an excellent set-up for a company in the midst of a possible turnaround.
At this point, TDC has more than $7.20/share in cash although 98% of the cash is offshore. It also has long-term debt of $552 million. The current enterprise value is $3.44 billion which produces an EV/S for the current year of 1.49X. Based on the company's current projection, the free cash flow yield for TDC will be 8% or so. The company indicated that there is potential upside to the free cash flow estimate based on the year-ending profile of assets and liabilities, particularly A/R. The company has a P/E of 12X current year non-GAAP earnings. Stock-based comp is quite low at around 10% of reported non-GAAP earnings. The other adjusting items have to do with one-time charges related to the disposition of the company's marketing assets business as well as reorganization costs. With those kind of valuation metrics, there is plenty of upside if the company's efforts to re-invent itself are even marginally successful. With that level of valuation, the company presents a very attractive acquisition target to both strategic and private equity investors. In the wake of the company's guidance for the next two quarters, I think downside exposure is very limited as well.
The company may not get sold - the CEO said he wanted to see the turnaround through - but there will almost certainly be offers. At the least, the company has a customer base that includes 40% of the Fortune 500 and that kind of customer base could make TDC attractive to a host of strategic buyers, while with an 8% free cash flow yield, the temptation for P/E buyers is likely to prove overwhelming.
It is hard to believe now, but at one time exiting the Great Recession and for a couple of years after that, TDC was thought to be a growth superstar and was given the best that institutions could offer in terms of valuation and free passes. The company bought one of hottest unicorns of the day in Aster Data, and there were rumors that Dayton, Ohio, its corporate home would become the "silicon farm."
And then reality set in. At first it was just brokerage seminars regarding the many Big Data appliances and Big Data open source software that were coming to the market. But over time, the entire business model imploded and the senior management found itself in denial and unable to take the dramatic steps that were necessary to develop a strategy that was designed to address the competitive realities of both the cloud and the multitude of Big Data solutions that had seemingly developed while Dayton had slept.
To be totally fair, it would have taken someone with the strength of a Hercules, the intelligence of a Socrates and the articulateness of a Pericles to pull off this transformation without lots of blood and angst. It isn't terribly surprising that the men who had lead the company successfully through its quiet past were simply not up to the task of making a series of difficult decisions that would have gone against everything that had made TDC successful in its past.
As Abraham Lincoln had once said, "The dogmas of the quiet past are inadequate for the stormy present… We must think anew and act anew and then we will save…" And no, President Lincoln was really not thinking about Teradata when he wrote to the Congress in December of 1862.
Here is how the engine gets restarted!
There are three parts to any business transformation. The first of these, often unrecognized is replacing the old management. For Teradata, that started just a bit more than 2 months ago with the appointment of Vic Lund as CEO. Mr. Lund had been an outside TDC director and chairman of the audit committee and he has had other experience in the tech world. Regardless of anything else, it is far easier for a new broom to sweep away all the detritus than would ever have been possible in any other fashion. Just yesterday, the company announced that it had dismissed its erstwhile COO. The head of European Consulting has been brought back to the US to run that function globally. Extractions are always painful, but they are most often necessary and the course of extractions is likely to continue.
Mr. Lund talked about a few things that probably resonated significantly with many investors. The first of these had to do with the fact that TDC is finally prepared to offer its technology on both Amazon AWS and Microsoft (NASDAQ:MSFT) Azure. It sounds more or less incredible that this hasn't happened until now, but to say that the old management was resistant to change is really an extreme understatement.
Mr. Lund talked about embracing open systems technology - specifically Hadoop - but there are other Big Data alternatives and Mr. Lund sees collaboration with all of them based on customer demand. This has been an incredible sticking point with customers - as well as most outside observers so far as that goes - who have wanted to use a combination of TDC and open source which has been resisted by the prior management.
Mr. Lund talked about providing the sales force with the tools, infrastructure and direction that it needs in order to be successful. For many years now, until very recently, checks I have made had always come back that the TDC sales force has been ill-staffed, ill-supported and ill-directed and far too highly paid for what it had been able to accomplish.
There is more than a little that Mr. Lund said that needed saying. The company has been mis-run and almost run into the ground by past management. Has the company waited until too late? There will be some who will say that it has, and no one can gainsay them with any specific evidence at this point. One might question the speed with which all of the changes and the strategies Mr. Lund spoke to can be successfully implemented. I think it would be harder, however, to doubt the man's commitment and his fervor with the task he has undertaken.
Usually, the first marker in trying to determine the odds of success for an organization is for observers to ensure that the management at least knows where it wants to go and how it might get there. Mr. Lund and his team seem very well aware of where they want to go and how they might get there. Mr. Lund knows very well where he wants to go. As the song in South Pacific goes, "if you don't have a dream, how you gonna have a dream come true." He certainly has his dream!
The second major component of most transformation I have seen usually consists of cost rectification. There are two parts to right sizing an enterprise. One of those consists of simply reducing headcount and disposing of surplus facilities. That is the easier than the other part which consists of ensuring the company has the appropriate resources to address business opportunities. The company has wiped out lots of costs - part of the significant overattainment in EPS was that costs have come down more dramatically than forecast.
Overall, selling general and administrative costs fell by about 10% year on year while research and development costs contracted by about 13%. Based on commentary this morning, it seems as though the company may have overshot its cost containment strategy and it will be adding back some development resources and some sales infrastructure resources going forward. While the magnitude of those increases isn't entirely clear, the company's forward guidance, which was unchanged in terms of both revenue and EPS despite the Q2 overattainment, suggest that the need to rebuild is not insubstantial.
The other of the issue is going to try to find a way forward for the company. That is to say, can Teradata find a niche for itself in the modern, cloud-centric world competing against technologies that were born, when its "enterprise data warehouse "concept had reached maturity? Needless to say, there isn't some simple definitive answer to that question, and the odds are that most observers are only going to recognize that the transformation has taken hold in arrears. Lacking my serving of prescience means that I really don't anticipate that I will have the foresight to proclaim, "this is the transformation" before it happens. But short of seeing the empyrean, there are elements of the transformation that ought to be visible in a quantifiable fashion to show real progress.
What are the chances of pulling it off?
I recently read a column by Michael Barone who writes for the Washington Examiner and is a commentator for Fox News. Mr. Barone had recently interviewed 12 senior officials from both major parties regarding the coming electoral contest. 10 of 12 Republicans and 11 of 12 Democrats said that their candidate was going to win. What does this have to do with Teradata? Basically the column says it isn't clear what is a winning strategy. In this case, the question isn't quite what is a winning strategy, but whether management can pull it off? No one really can forecast those things before they actually happen.
I liked what I heard from Vic Lund. He recognized that TDC had been trying to force users to buy what they didn't want to buy and to buy it on terms that were no longer suitable to the way they wanted to do business. He recognized that the public cloud was a major factor in the IT world and that TDC has to have a set of hybrid cloud offerings to appeal to its large user base or they will no longer continue to buy from TDC. He understands the issues that have arisen regarding open source and Big Data. And to me, last but hardly least, he recognizes the issues of a disaffected sales force with mediocre leadership that has more or less been left without an effective product strategy road map to articulate. But as he was first to acknowledge on the call, articulating what needs to be done and then getting it done are two very different things.
From my perspective, the issue is really going to be one of sales execution more than any other single factor. Many of the required solutions that TDC can sell are either on the cusp of launch or will be in full GA within the next 12 months. Putting the right technology in the market is not an insurmountable hurdle.
The other horses in the race are not foes of insurmountable prowess. But as Mr. Lund suggested on the call, TDC has a long road in terms of getting its users to think of the company as a vendor that has what customers want to buy, packaged in ways that are far easier for users to acquire these days, and at price points that are competitive. TDC has a reputation of being stodgy, inflexible and not easy to do business with, and that perception has to be fixed, and is far more than a matter of a global tour on the part of the new CEO. A lot of what has been lacking at the company is simply a reasonable way of presenting current and new users with TDC solutions packaged and presented in a way that makes it easy for users to do business with the company. Just how easy it will be to turn around perceptions and re-engage the sales force and the customer base is not something that is easy to handicap. Whatever else is true, it is going to take a few quarters and the path to success is not going to be a straight line.
Transitions and Transitions!
Mr. Lund was reasonably forthright about some of the impact regarding one of the transitions that TDC is going to go through the next several years should it remain independent. The fact is that subscription revenues and cloud services are going to significantly displace product revenues in the mix over the coming quarters and that is not going to help headline numbers. During the course of the call, Mr. Lund cited two 8-figure transactions that had been booked, but which were being recognized ratably. To what extent overall revenues may have been impacted by a mix switch to ratable transactions was not made clear. Just how much this change is going to impact future revenues was not quantified - and I am not too sure that if it had been I would have put too much stock in such a forecast. It was acknowledged that one of the reasons that revenue guidance and earnings guidance remained unchanged despite the Q2 overattainment had to do with the likely impact of the mix shift in the next two quarters.
The guidance for the balance of the year and the consensus forecast for next year suggest no top line growth. How that reconciles with some bookings metric that reflects a mix shift to a ratable model is not known.
About all we know is that the guidance provided does reflect the impact of the transition. How much that transition might impact 2017 results is not really forecast although both Mr. Lund and CFO Steven Scheppmann said that both operating expense and research and development would increase in the next two quarters and in 2017 as well. So, this may be a case in which business metrics are improving but headline numbers are not showing comparable improvement. Faced with similar issues, many companies would introduce bookings disclosures, and might even go so far as to present a reconciliation between reported numbers and the reported business value of bookings in terms of adjusting the P&L. I have no idea if this company will decide to attempt to better display its progress in that fashion, but it might be significant in terms of the outook for the shares.
Also not quite clear to me is how the company's sales of products within both AWS and Azure are going to be most likely recorded. Management suggested that there are some transactions of scale that are likely to take place early on as the AWS offering in particular has been extensively tested and should be ready to go. To what extent these transactions will be recognized ratably as they are "in the cloud" was not discussed with any level of granularity.
The latest market research that has been released with regards to the business potential of the Big Data/Analytics market in which TDC competes is that it will increase by 50% (the exact CAGR is just above 11% and that it will be centered on services.
Given the strategy that the company articulated in this morning's conference call, it is not inconceivable that the company could grow in line with the market through 2017 although that growth would be weighted heavily in the two last years of the period. Management talked extensively about the need to enhance its consulting capabilities in order to provide an objective path for clients to achieve their goals in Big Data/Analytics. That indeed is what IDC study, cited above, suggests will be the sweet spot for user demand.
But at this point, just about no one in the analyst community expects that TDC will be able to execute successfully and the fact that the shares have climbed above the consensus analyst target price is a graphic of that kind of expectation.
The litany goes that TDC is a dinosaur, it has missed out on the industry transformation and it isn't even aware that it has done so. Its salesmen hate it, and the good ones are looking to change jobs and the less qualified are using their employment as a safe haven. Again, the negative case goes on to articulate that its customers are looking for alternative vendors.
Frankly, that is all history, and accurate history at that, but it is not an objective effort to try to discern the probability of a new management with a very large and very clean broom being able to capture just some of the opportunity that consultants believe exists in the company's market space. The fact that the short interest is 15% of the float and that retail ownership of the name is essentially non-existent further demonstrate just poorly the company is perceived by investors.
Transitions are one of the more difficult things to call mainly because they force analysts and investors to throw away trends and in some cases long existing trends. And in this case, belief in redemption is going to go against the shibboleths of "technology correctness" so to speak.
How do you lay a bet when there are no real odds-makers?
If there were real odds-makers with real data about the future, then odds would be far less. I think that all investors can do is to look at potential risks and rewards. The risk is that the company will continue to lose share in a rapidly growing market. That is what has happened now for a few years and so it might continue to happen. But to a greater or lesser extent, that is what the consensus is forecasting - the risk isn't that the company will lose share, but that the company will lose share at an accelerating pace. The fact is, that this quarter's results actually reversed that trend by a marginal amount, and probably more so if adjusted for the impact of a few large deals that went ratable.
I've pointed out the valuation metrics earlier in this article and it is easy enough to see just how compressed is the valuation of TDC shares. I would say the risks are far less than meet the eye.
And the rewards. Well, I think that many observers would concede that what this company has would be worth a significant premium to an acquisitor. No, the place this company finds itself is not particularly in style. TDC is not really a cloud vendor, and we have no idea as to the percentage of its revenues that are based on renewable streams. However, given the continued tsunami of consolidation in the IT space and the valuation and the customer base, betting on a consolidation transaction with a major premium is not really a long-odds bet. And if it doesn't happen - well it seems to this observer as though management, at least at a 30,000 Ft. level is finally steering the army to a reasonable objective.
- Teradata announced a quarter in which it delivered a significant earning upside and beat by a noticeable amount on revenues as well.
- The company did not raise guidance for the balance of the current year despite its Q2 outperformance.
- The company's new CEO, Vic Lund, was pretty forthright about the reasons that TDC has not been an effective competitors and that its revenues have shrunk over the recent past.
- Mr. Lund laid out a comprehensive program delivered articulately to steer the company to renewed health.
- The company is going to provide far more choices to its customers in terms of cloud and open source.
- It plans to equip its salespeople with necessary infrastructure and with a more pertinent direction to allow them to achieve significant success.
- The Big Data/Analytics market in which TDC competes is large and continues to enjoy a double-digit CAGR.
- The company has valuation metrics that allow investors to speculate that a consolidation transaction with a significant premium has a significant probability.
After months of strong growth on the part of the high tech index, it has become increasingly difficult to find companies of some scale and some profitability that have valuations that make them suitable candidates for value investors. Teradata has started what will be a long and arduous path to recovery, but its valuation pays investors for the wait. It should be on the cusp of achieving positive alpha.
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.