Unless your name is Qualcomm (Nasdaq:QCOM), serving the wireless device market is a tricky proposition, as constant ASP erosion is a fact of life and the prospect of losing sockets always looms. Investors in Atmel (Nasdaq:ATML) have seen that firsthand, as this large microcontroller company has suffered from competitive socket losses and market shifts toward cheaper alternatives. With new product opportunities on the way and the prospect of improving operating leverage, though, these shares have started to recover. The question for investors is whether the company can deliver even more upside than these improving expectations incorporate.

SEE: Turnaround Stocks: U-Turn To High Returns

A Win At Samsung, A “We'll See” For PCs
Earlier this year Atmel confirmed that it had been selected as the sensor hub for the Samsung Galaxy S4 phone. While this is a significant win into a successful product, it wasn't a complete victory. Synaptics (Nasdaq:SYNA) got the touch controller socket, and Samsung has recently been paring back its component orders for this platform. Still, with an estimated ASP of $1 for the sensor hub, even the recent revisions in S4 sales (the JPMorgan analyst changed his estimate from 80 million units to 60 million), isn't a material event for Atmel.

What is more material is the failure thus far of Microsoft's (Nasdaq:MSFT) Windows 8 to really ignite sales of touch-enabled notebooks. Atmel has logged several design wins tied to Win8, but customers have yet to step up to the degree once hoped. While bullish analysts continue to advise patients and suggest a that a big second half improvement is coming, investors should at least consider the possibility that the touch-enabled notebook/ultrabook market never quite lives up to billing.

Another “we'll see” portion of the story is the company's new xSense technology – a replacement for ITO sensors that allows for edge-to-edge displays at competitive (and profitable) prices. While getting everything up and running has taken slightly longer than Atmel expected, apparently at least one PC maker is already on board with this technology and this could help offset the sluggishness in Win8.

Operating Leverage On The Way
Atmel's margins should be about to improve, and improve to a meaningful extent. Take-or-pay foundry agreements roll off this year, creating the opportunity to lift gross margin by multiple points. What's more, assuming that Atmel sees the growth in non-touch microcontrollers and RF/auto that most analysts expect, better utilization and better overall operating margin should also be on the way. That should go a long way towards lifting Atmel's free cash flow (FCF) margins from the very low teens of recent years and more towards the mid-to-high teens of quality chip names.

All told, better leverage should be a multi-year theme here. Atmel has grown to become the third largest microcontroller company (behind Renesas and Freescale (NYSE:FSL), and ahead of Texas Instruments (Nasdaq:TXN) and Microchip Technology (Nasdaq:MCHP)), and additional opportunities in markets like sensors should offer incremental leverage opportunities.

The Market Isn't Going To Get Easier
For better or worse, the touch market isn't going to get substantially easier for Atmel, and it very well could make the stock a product launch/cycle story for many investors. Synaptics has won several smartphone sockets and Asian chip companies are applying steady pressure on ASPs. At the same time, companies like Nvidia (Nasdaq:NVDA) and Broadcom (Nasdaq:BRCM) are increasingly looking to get sockets with chips that bypass or include discrete touch controllers. While Atmel isn't just about touch controllers (witness the sensor hub win in the Galaxy S4), it's still going to make for ongoing challenges.

SEE: A Primer On Investing In The Tech Industry

The Bottom Line
As the Street has gotten more optimistic about Atmel's operating leverage opportunities and overall growth prospects (including non-touch microcontrollers), the stock has recovered pretty meaningfully. Even with a long-term cash flow growth forecast above 10%, it's difficult to arrive at a fair value for Atmel much above $9. Accordingly, while I would reconsider these shares on a pullback, they don't offer quite enough upside today to offset the volatility and headaches that are likely to go with wireless device and notebook/ultrabook cycles.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.