Teradata's Dominance Wearing Thin in Warehouse Space

Moats in the information technology industry are hard to sustain over long periods of time, as IT companies are continuously threatened by nimbler, larger, or better capitalized competitors seeking to offer more valuable products. We think  Teradata's (TDC) narrow moat is shrinking as a result of emerging competitive converged systems for data warehousing. While Teradata's data warehousing systems traditionally have dominated the high-end segment of this market, larger and better-positioned IT vendors such as  Oracle (ORCL),  IBM (IBM), and  SAP (SAP) are rapidly encroaching on Teradata's turf.

Teradata has been a major vendor in data warehousing by selling high-end systems that consist of an analytical database tightly integrated with standardized servers. Teradata's products, which are specifically designed to support online analytical processing (OLAP) operations, gave the company a source of competitive differentiation because other database vendors have tailored their products for online transactional processing (OLTP) workloads. As the graph below illustrates, the market for relational databases (OLTP) is far bigger than the market for data warehousing databases (OLAP).

The Value of Data Warehousing
During the last decade, data warehousing systems have steadily increased their relevance among organizations that use information technology as a source of competitive advantage. In a nutshell, warehouse projects are vast corporate databases that store, integrate, and combine data from multiple IT systems, such as enterprise resource planning or transactional systems. Data warehouses are valuable because they enable business intelligence systems to extract useful information to answer strategic and operational questions about their businesses on a timely basis.

Armed with a data warehouse, a company can have a holistic view of its operations, track key performance indicators against goals, and use data to proactively manage its business. In fact, data warehouse deployments have gained the status of strategic information assets, particularly in consumer-oriented industries such as retail, financial services, and telecom. For instance, retailers have long utilized data warehouses to study the correlation between sales of different products. The classic example is a grocery store's discovery of the odd correlation between diaper and beer sales on Friday nights. Looking at it closely, the retail chain found that when fathers on their way home from work stopped to pick up a package of diapers, they also bought beer. As expected, the retailer placed diapers alongside the beer and sales of both items increased.

Stiff Competition From High- and Low-End Products
Teradata has faced increasing competitive pressures from high- and low-end products during the last three years. At the high end, Teradata is facing increasing competition from Oracle's Exadata and SAP's HANA systems, which are shaping up to become viable alternatives to Teradata's Active Enterprise Data Warehouse system. Oracle's Exadata is an appliance that can handle both OLTP and OLAP operations. Without delving into the technical trade-offs of this approach, the key takeaway is that Exadata's ability to support both types of operations represents a compelling value proposition to certain clients.

At the low end, Teradata could cannibalize sales of its high-end solutions as a result of the company's introduction of data warehousing appliances, which on average sell at about one third of the price of its high-end systems. Prodded by IBM's Netezza appliances, Teradata launched slimmed-down versions of its flagship product in 2008. These appliances offered different degrees of performance, storage, or scalability specialization. While cheaper appliances allow Teradata to expand its customer base, the key risk with this strategy is that some clients haven't noticed a substantial difference between Teradata's high-end and low-end appliances. Therefore, the threat to Teradata is that some clients will find low-end appliances to be good enough to satisfy current data warehousing requirements and thus postpone purchases of the company's higher-end systems.

Constrained Distribution Capacity
Another disadvantage for Teradata is its relatively small distribution capacity compared to larger IT vendors. To date, Oracle has sold about 1,000 Exadata systems, which would represent about $1 billion in revenue. In contrast, after being in the data warehouse industry for 32 years, Teradata is on track to generate $2.2 billion in revenue this year. Oracle's management has the aggressive goal of tripling the number of Exadata systems in fiscal 2012, which we believe is achievable. Similarly, SAP and   Microsoft (MSFT), which also have strong product distribution capacities, are well-positioned to gradually displace Teradata.

Bleak Long-Term Prospects
To improve the value proposition of its products, Teradata recently acquired two software companies. These firms, Aprimo and Aster Data, increase Teradata's exposure to marketing-campaign and unstructured-data analysis, respectively. Therefore, we expect the company will continue to have attractive business opportunities in the near term. However, the long-term picture looks bleak. We expect lower-end appliances increasingly will account for a larger portion of Teradata's revenue. This, combined with higher research-and-development expenses required to fend off competitors will, at best, keep operating margins flat.

Stock Ideas
A few companies that stand to benefit from wider adoption of data warehousing systems, and that are attractively priced include Oracle, a company that is well-positioned to extend its presence in the data warehousing segment as a result of its dominance of the relational database market. In addition, the company has a strong portfolio of business intelligence products, which are required to extract valuable information from data warehouses. Management has positioned the Exadata solution as the preferred vehicle to deliver the company's pervasive database among its top clients. On top of handling the traditional database needs of its clients, Exadata also provides a similar functionality to Teradata's flagship product, so we expect Oracle to steadily displace Teradata's presence in key large accounts.

Microsoft has room to the upside. The company displayed its interest in the data warehousing appliance market when it acquired privately held DATAllegro in 2008. Since then, the company has partnered with  Hewlett-Packard (HPQ) to offer the Enterprise Data Warehouse Appliance and other workload-specific systems, such as Azure. In addition, Microsoft has partnered with IBM to bring integrated business analytics appliances to the market.

Hewlett-Packard is trading at a significant discount to our fair value. To increase the value of its hardware products, the company is offering an array of integrated systems aimed at different IT workloads, such as data warehousing, business intelligence, and OLTP. In addition, the company acquired privately held Vertica Systems earlier this year to further its presence in the OLAP market. HP has been partnering with other software vendors, such as Microsoft and SAP, to provide the hardware components of appliances aimed at competing with Teradata.