Update: Digi International Earnings Show No Sign Of A Sales Rebound

Jul.28.14 | About: Digi International (DGII)

Summary

Digi International reported the third mediocre quarterly results in a row, dampening hopes of a sales growth turnaround.

While margin deterioration and sales growth slowdown were anticipated by the thesis, the speed and magnitude surprised both me and the company.

I remain bullish on the machine-to-machine trends. I will give DGII two more quarters to show a sales rebound before switching to stronger competitors Sierra Wireless and Gemalto.

Sales of Digi International (NASDAQ:DGII) dropped 4.8% year-over-year in the second quarter and 2.1% for the nine months ended June 30 after growing for the previous year. What is even more worrisome, the growth of the "growth" categories of products and services has completely stalled. These categories were supposed to deliver the overall DGII's future sales growth and were the backbone of my previous long thesis. With these growth drivers absent or very unsure, future growth prospects are very grim, and my valuation as well as the stock price took a large hit.

Sales of M2M companies (machine-to-machine communication, Internet of Things) are usually very lumpy from quarter to quarter due to project-based nature and large orders from OEM partners that are often shifted several quarters back or forward. However, the current swoon has lasted for the third quarter already, showing no signs of a turnaround. For me, this is a clear sign that competitive pressures are taking its toll on DGII's market share because its main competitors, Sierra Wireless (NASDAQ:SWIR) and Gemalto (OTCPK:GTOMY), have both been able to grow sales in the past 12 months, proving that the M2M industry is alive and well.

I remain bullish on the long-term potential of the machine-to-machine and general Internet Of Things trends, and view DGII as being fairly valued now. Therefore, I will give the company two more quarters to prove itself. If sales growth does not return, I will switch to better positioned companies in the sector trading at comparable valuations, such as Sierra Wireless with a dominant market share of ~35%, or Gemalto. All three M2M stocks have been similarly punished for being small-caps/mid-caps since the start of 2014, and fell also as a result of the cooling risk appetite for their highly volatile future growth potential. So they all present a fairly valued investment proposition.

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