The last six months have not been easy ones for small-cap semiconductor equipment and product companies. Those with exposure to LED, solar, or other non-semiconductor markets like Advanced Energy Industries or Veeco have done alright, but it has been a more challenging run for the likes of Mattson (NASDAQ:MTSN), FormFactor (NASDAQ:FORM), and Cascade Microtech (NASDAQ:CSCD).
I'm still relatively bullish on Cascade, though. True, order and activity levels have not picked up as much as projects back six months ago, but Cascade is still leveraged to the increasing sophistication of chip production, as new process nodes, materials, structures, and wafer geometries will all require the company's probe cards. What's more, management has launched new tools like the CM300 and APS200 and acquired new capabilities that should make it more competitive in the wafer probe markets for advanced logic and SoCs.
Is The Turn Close?
This was supposed to be the year that major chip producers like TSMC (NYSE:TSM), Intel (NASDAQ:INTC), and Samsung (OTC:SSNLF) stepped up their capex and the production of smaller, more complex next-generation chips. Time will tell whether those orders actually materialize, though, as the recent trend in the market has been one of abundant sell-side optimism early in the year, only to be followed with explanations as to what went wrong.
In the case of Cascade, maybe things have started turning around. Revenue was only up 6% in 2013, and closer to flat if you exclude the benefit of acquisitions. Along similar lines, system revenue would have been down about 7% in the fourth quarter without the acquisitions, while probe sales were up just 2% yoy as production probe card sales were weak.
The good news was that bookings improved, hitting an all-time high of $39M in the fourth quarter. Management does not consistently provide information about bookings beyond the book-to-bill ratio, but working backwards from that indicates about 30% growth yoy and sequentially in orders. It's going to take more than one good quarter of orders, but that is a step in the right direction.
It's Tough Elsewhere, Too
I think it's important to note that while Cascade came in a little light in the fourth quarter and 2013 was a challenging year overall, the company is not doing badly on a relative basis. FormFactor saw weak yoy and sequential performance as well, due in large part to weak results in DRAM and flash. Conditions being what they are, FormFactor also announced a restructuring and cost reduction program in late January. While Cascade has been profitable the last two years, FormFactor's annual reported losses now stretch back for six consecutive years.
This comparison is not entirely fair without at least pointing out that FormFactor and Cascade run different models. FormFactor has long been focused on the memory side of wafer probing, where the addressable market is large but volatile and lower-margin. FormFactor has paid more attention to the SoC market since the 2012 acquisition of MicroProbe and estimates that it has about 29% share of this market.
Is The Trend Still A Friend?
As semiconductor fabs increase their production of FinFETs, chips with micro-bumps, and other assorted advanced features, it ought to drive more demand for the company's production probe cards. Wafer-level testing is significantly more cost effective than testing the packaged product, particularly as these latest generation of chips have even more advanced packaging needs.
Cascade has also been investing to step up its game in product capabilities. Acquiring Aetrium's reliability test products business gives the company more wafer-level reliability capabilities, while the addition of ATT brought technology for advanced thermal systems in wafer testing.
If chip companies are going to produce larger volumes of more sophisticated chips, that trend should serve Cascade well. FormFactor and Micronics are certainly viable competitors, but this trend toward more sophisticated chips ought to play to Cascade's claimed advantages in handling more complex chips. At a minimum, though, I would keep an eye on equipment orders at companies like Agilent and Teradyne - if semiconductor companies are not ordering as much production test equipment, that's eventually going to spill over into demand for Cascade's cards.
Still Looking For A Solid Multi-Year Run
Cascade is likely never going to be a buy-and-hold stock for the full cycle. Rather, my expectation is for Cascade to see a few years of accelerated revenue growth (high single digits to low-to-mid teens) and strong margin leverage. I do expect long-term revenue growth of over 6% and improved long-term FCF generation, but the history of this company and this industry is for erratic up-and-down cycles of profitability.
The Bottom Line
For that reason, long-term DCF models are of limited use. My model suggests a potential fair value between $11.50 and $12, but there are so many variables that go into the shape of the semiconductor cycle that it is more of a guideline to me.
What I do find more interesting is that the company appears undervalued on an EV/revenue basis. In the semiconductor equipment space, there are correlations between operating margins, returns on invested capital and while correlation is not causation, Cascade seems relatively undervalued for its margins and ROIC. Were Cascade to trade more in line with its peers, an EV/revenue multiple of 1.5x would be more appropriate, suggesting a potential undervaluation of around 25%.
Given that Cascade is under-followed, has a small float, and isn't especially liquid, investors considering these shares need to appreciate the risk that they remain overlooked. That said, the company's profitability doesn't seem to get its due (let alone credit for management's goals of improvement) and these shares appear to be an undervalued play on the breaking up of the logjam in semiconductor spending.
Disclosure: I 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.