Teradata: justifying a higher stock price (NYSE: TDC)
Teradata (NYSE:TDC) delivers FCF and EPS growth in the growing cloud market. The company is also reporting a significant amount of recurring revenue and net sales growth is likely to continue. With new tools and partnerships with other big cloud players, in my opinion free cash flow will likely tend to increase. Despite cyber attacks or any failure to forecast future operating expenses, the business remains a buy. At best, my DCF model offered a fair price of $89, which is considerably higher than the current stock price.
Teradata sells a connected multi-cloud data platform for enterprise analytics. Enterprise customers use the company’s software to assess data at scale to answer difficult business questions. The company has been recognized by Gartner and Forrester as a cloud leader. The company’s financial numbers are splendid with 2021 FCF 100% y/y growth and 86% GAAP EPS growth:
The geographic distribution of the company’s sales is also quite diverse, which I believe will make future net income less volatile. Additionally, in the latest quarterly report, Teradata reported that more than 63% of its total revenue across all continents is represented by recurring revenue. We can therefore expect future FCF and sales to be stable:
The outlook looks a little more pessimistic than the cloud database market
I believe the outlook is less optimistic than the general market conditions of this market. With that in mind, I wonder if Teradata could see higher revenue growth than originally projected. Note that the cloud database market is expected to grow at a CAGR of 38.2%:
The global cloud database market size is expected to reach USD 68,720 million by 2026, from USD 7,054.4 million in 2019, growing at a CAGR of 38.2% during 2021-2026. Source: Evaluation reports
According to the most recent report, Teradata expects to generate total revenue growth of $400 million in 2022 and $400 million:
Also, note that total capital expenditure is expected to decline to $30 million in 2022. If management does not need to invest a significant amount of capex in the near future, we should expect FCF tends to rise:
In this scenario, I believe management should be able to bolster their multi-cloud data platform by offering next-gen cloud capabilities. I would also expect a successful improvement in user experience and deeper integration with cloud ecosystems.
Management should also help customers accelerate their transition to the cloud by supporting them in their migration journeys. With all of these assumptions, I would expect revenue growth roughly in line with management’s expectations.
I would assume sales growth of 4.97% in 2023 and sales growth of around 2% from 2025 to 2028. If we also assume an EBITDA margin of around 27%, the 2028 NOPAT should be at nearly $243 million. Finally, with working capital variations around $53M and $4M and capital expenditures close to -$30M, FCF 2028 should be around $284M.
Note that my figures are not really out of the box. In the past, Teradata reported D&A close to $41 million, and working capital changes were close to $149 million:
Teradata is currently trading at 11x forward EBITDA, but the industry median is trading at 13.95x. I took into account the valuation of other competitors for the assessment of the exit multiple:
In total, with a beta of 0.94, a cost of debt of 4.25% and a cost of equity of 7.3%, the net present value of future FCF should be close to $1.57 billion. . Now I also used a conservative exit multiple of 11x, which implied a terminal value NPV of $3 billion. The result is an implied price of $43:
Best case scenario
In this scenario, I assumed that Teradata would successfully deepen strategic relationships with public cloud service providers. Additionally, management will likely focus on enabling partners to drive solution execution on Teradata Vantage. Let’s be clear that the company is actively pursuing adoption of the company’s Teradata Vantage software, which will most likely drive revenue growth in the future:
In terms of new customer acquisition, we aim to drive adoption of our Teradata Vantage software. Additionally, we are working with our existing customer base to increase awareness and usage of Teradata software. Source: 10-k
Also, in this case, the company’s sales and marketing strategy should work well. With more than 80% of company employees working face-to-face with customers, in my opinion, Teradata will be able to build awareness and increase the perception of Teradata as a multi-cloud leader:
We primarily sell and market our solutions and services through a direct sales force. More than 80% of our employees are in customer-facing and/or revenue-generating positions. Source: 10-k
Finally, in my opinion, if Teradata can continue to strengthen its partnerships with major service providers, it will be easy to reach other major players in the cloud industry. To date, Teradata’s partnerships are quite impressive:
Teradata has partnered with the world’s top three public cloud service providers: AWS (NASDAQ:AMZN)Microsoft (NASDAQ: MSFT) Azure and Google (NASDAQ:GOOG) Cloud. Source: 10-k
In the best case, my sales growth is a little higher than the previous case. I used 8% net sales growth in 2024 and 8% to 4% sales growth from 2025 to 2028. Also, with an EBITDA margin of 27% and effective tax of 23%, the 2028 NOPAT is expected to be $480 million. I have not made any significant changes to my working capital, capex, and D&A figures for FCF to grow from $354 million in 2022 to $521 million in 2028:
Under these favorable conditions, I think the assumption of a WACC of 6.10% is very appropriate. This implies a DFCF sum, from 2022 to 2028, of nearly $1.98 billion. Moreover, with an exit multiple of 15.10x, the net present value of the terminal value would equal $7.6 billion. Eventually, the price would equal $89:
Risks and worst-case scenario
Teradata brings in a significant amount of recurring revenue. However, most net sales come from a subscription model, which can vary widely. As a result, it is difficult for management to make accurate predictions about the future. In the worst case, Teradata may not recognize future global load and operating expenses, which could adversely affect future FCF estimates. If analysts don’t believe Teradata’s outlook, demand for the stock could decline:
The pace and extent to which customers will continue to purchase and renew our offerings on a subscription basis is variable and therefore impacts our results and operations. Additionally, we offer flexible pricing options for our cloud customers, including consumption-based, “pay as you go” pricing. Under such a pricing model, we typically recognize revenue based on consumption. To the extent that customers opt for such a flexible pricing model, we may not be able to accurately predict when customers will consume our offerings. Source: 10-k
In the past, Teradata has suffered cyberattacks, so they are likely to happen in the future. If hackers manage to obtain sensitive company information and journalists find out, Teradata risks losing its reputation. As a result, FCF estimates for the future could drop:
We have been subject to actual and potential cyberattacks, and there can be no assurance that our defensive measures will be adequate to prevent them in the future. There is a risk that these types of activities will recur and persist, that one or more of them will succeed in the future, that one or more of them will have succeeded or will succeed but go undetected, prevented , corrected or mitigated by us. Source: 10-k
In this scenario, I think a 10% WACC is fair. Keep in mind that Teradata may not receive cheap funding if the business goes downhill. I also assumed 1.5% sales growth from 2024 to 2028, and an EBITDA margin of -10% in 2027. Under these conditions, free cash flow would drop from about $355 million in 2022 to nearly $395 million in 2028:
If we put everything together, the sum of FCF from 2022 to 2028 would equal almost $1.65 billion. With an exit multiple of 5x and a 2028 EBITDA of $555 million, the sum of terminal value and FCF would equal nearly $3.2 billion. Finally, the implied price would equal $30. In light of these results, I think there is more upside potential than downside risk.
With an asset/liability ratio above 1x and a cash position of $592 million, I think management is well equipped to design new tools and invest in marketing:
I’m not concerned about Teradata’s long-term debt. Given that the company’s net debt is close to zero:
Teradata is a leader in a growing market, and management reports growing FCF generation and EPS. In my view, if management designs new tools and signs new partnerships with other major cloud players, revenue growth will continue. I see some risk of hackers and the possible failure of FCF predictions. However, the current stock price does not reflect the fair value of the company. At best, the fair price is close to $89, which is significantly higher than the current stock price.