Semiconductors and semiconductor equipment are sizable sub-sectors within the technology sector and investors are certainly not lacking in alternatives to play the eventual recovery in chips. One name that is likely not on most investors' lists is Cascade Microtech (Nasdaq:CSCD). This company is an interesting turnaround speculation; on one hand, it should be clearly leveraged to a healthier chip market and the expectations are low. On the other hand, even in the best of times this company has never been a top performer and there is the risk that the company languishes as a value trap. (For more, see Earning Forecasts: A Primer.)

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Probing for Problems
Cascade Microtech is largely in the business of helping chip companies find problems early enough to do something about them. Operating in the broadly-defined electrical measurement and test space, Cascade sells stations and cards designed to assess the performance of chips in the research and development (R&D), early production and post-production phases.

A company like Intel (Nasdaq:INTC) or Samsung can use Cascade probe stations to test the performance of experimental chips, as well as using them to optimize the fabrication process for new lines. Not surprisingly, then, Cascade also sells to fabrication companies like Taiwan Semiconductor (NYSE:TSM).

The other side of the business is probe cards. These cards basically assess the chips after they are fabricated, but before the wafers are cut and the chips are shipped. Cascade offers its proprietary Pyramid cards and tries to compete on the basis of product features like accuracy, speed, efficiency and durability. Cascade has tried to target higher-end markets like wireless and counts companies, such as Broadcom (Nasdaq:BRCM) and RF Micro Devices (Nasdaq:RFMD), as major customers.

A Fixed and Consumable Component
In theory, Cascade has a good business mix split between "fixed" systems that chip companies need for R&D and manufacturing and a "consumable" component in those probe cards, which do wear out with use. That may well be true, but it doesn't seem to benefit this company the way "razor/razor blade" models usually do.

The reality is that chip production levels are extremely volatile and also correlate, to some extent, with chip R&D. In other words, when chip sales start to fall, so too does the investment in R&D-oriented equipment like probe stations.

Limited Competition, but Also Limited Leverage
The companies that compete with Cascade are not household names to most investors. Cascade bought its biggest rival in probe stations back in 2010 (Suss MicroTech) and goes up against companies like Vector, Micromanipulator and Wentworth. In the card space, it's up against other relatively unknown names like Mesatronics and PHICOM, as well as publicly-traded names like Tokyo Electron (OTCBB:TOELY) and FormFactor (Nasdaq:FORM).

Unfortunately, while probe cards are important to the chip companies, they are very nearly commodity products. As such, Cascade has never enjoyed especially good margins, returns on capital or free cash flow production.

Signs of Progress Amid Trouble
Certainly this has not been a healthy operating environment for Cascade, and the financial performance shows it. Still, there have been some incremental positives. Orders have been growing, although deliveries have been getting rescheduled and pushed back, and the company has made progress with its internal operations that should show up in higher margins when the sector recovers.

The Bottom Line - Minimal Expectations Leave Upside
Although the majority of large chip concerns seem to think that the chip sector is bottoming out and should show a real rebound starting later in 2012, little of that shows up in Cascade's valuation. There are only two analysts who follow this stock and their estimates suggest a sedate rebound.

The key to Cascade as a turnaround stock is whether or not the company can ride a rebound and regain (and then hold) mid-single-digit free cash flow margins. If the company can do that, it could be a worthy buy, even if future cash flow growth is only in the low-to-mid single digits.

If things go right and Cascade rides the rebound, this could be a $5 stock. At the same time, it's not impossible to think that a company like Teradyne (NYSE:TER), Agilent (NYSE:A) or Danaher (NYSE:DHR) could look to add this company as a tuck-in deal in their test and measurement businesses. Unfortunately, there is little in the company's history to back up the idea that it can regain and hold such a level of performance, nor that these larger test companies want to get into this space. Investors need to realize that they could hold this stock for years, waiting in vain for a real rebound. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)

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