Description

Cascade Microtech (CSCD) is a small-cap semiconductor equipment company gaining market share in a growing market.  The company trades at 6.7x 2016E EBITDA and is growing the top line at a mid-teens pace.  The company is underfollowed by Wall Street but has been getting some more attention by investors recently as its P&L has performed well.  Management is top notch both in terms of execution and in terms of its message to investors.

Cascade makes probes and probe systems used to test wafers in the semiconductor manufacturing process.  The probe is mounted on the probe system and then makes contact with each die on the wafer, testing them to see if they perform to spec.  The probe itself is a consumable and grants a recurring stream of revenue to the company.  

Cascade makes probes and probe systems for two segments of the semiconductor industry.  Its engineering probes and systems are used in the semiconductor manufacturer's research and development process for new wafer geometries and materials.  These products tend to be less cyclical than many semi cap equipment types because R&D spend does not fluctuate as widely as production spend.  Its production probes and systems focus on testing wafers during the production process when they are being fabricated for customer use.  Cascade specializes in testing radio frequency (RF) chips that go into devices with communication capabilities such as cellphones.  As RF chips have become more complex and RF content has increased, there has been increased need for CSCD's products,

The company's systems business grew 6.3% in 2014, while its probes business grew 30.2%.  As probes carry a gross margin near 60% and systems have a 45% gross margin, the change in mix caused by the faster growth of the probes business drove up overall gross margins to 51.2% in 2014 from 45.6% in 2013.  Consequently, EBITDA margins grew from 13.1% to 16.6%.    

We believe that Cascade should trade at 18x 2016E EPS due to its secular growth and margin expansion plus its $2.41 in net cash on the balance sheet for a target price of $22.51 or 40% upside from current levels.

Catalyst

We think that results should be solid over the next two quarter as recent product launches at Samsung and Apple drive the company's RF probe business. This will in turn drive gross margin and allow the company to overachieve its EBITDA margin targets.  We also think that CSCD would fit well in a larger testing company such as Xcerra or Terdayne.