The M2M Money Machine: Digi International

| About: Digi International (DGII)
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The personal computer, the cell phone and the Internet revolutionized the way we live and do business. We're now on the cusp of another paradigm shift: Machine-to-Machine (M2M) technology.

M2M devices communicate with each other through a central server, without a human being as intermediary. They use sensors to transmit valuable data, such as fuel levels, room temperatures or inventory capacities, through a wired or wireless network to a software application.

The software application translates the data for meaningful action. For example, if the data exchange indicates that a refrigerated locker is getting too warm, the system will make a temperature adjustment, automatically and without a person getting involved.

M2M remotely connects a wide variety of machines into a complex communications matrix. Major applications today include utility meters, fuel tanks, vehicle fleets, point of sale scanners, and medical instruments in hospitals. M2M also automates the delivery of services and billing, making them more efficient and cost-effective.

During the last decade, M2M "smart meters" have transformed the utility industry. Technology research firm IDC predicts that shipments of smart meters to utilities will grow nearly 112 percent by the end of 2012 compared to 2011.

Under conventional technology, a remote network of machines sends data to a centralized hub for human analysis and action. M2M not only eliminates the flesh-and-blood middleman; it also fosters an integrated web of networks that can communicate with smartphones and other mobile devices. M2M networks dramatically reduce the cost, time and energy required for data transfer, opening new opportunities for businesses as well as investors.

What's more, the M2M sector is still relatively new, with huge opportunities for future growth, as the use of mobile telecommunications explodes around the globe.

The purest play on this trend is Digi International (NASDAQ:DGII), headquartered in Minnetonka, Minnesota. Founded in 1985, Digi is the pioneer in the creation of M2M devices and platform solutions. Digi also provides the most sophisticated line of cellular gateways specifically designed for M2M applications.

The company's iDigi Manager is the world's first ready-to-use cloud computing platform for M2M network management. The cloud is web-based computing that allows organizations to enhance IT capabilities without creating infrastructure, hiring new personnel or buying software. The company's product uses the cloud to weave all of these communications strands into a seamless fabric.

In a report, tech research firm Yankee Group said it expects the number of cellular connections in the US dedicated to M2M applications to nearly triple by 2015. Cellular carriers are embracing M2M, because they can offer it as part of a cellular package to both customers and businesses.

By getting onto the M2M bandwagon, carriers serve as the data carriage, garnering a fee for transmitting information to and from the remote devices. Some cellular carriers already offer M2M services, and their number is growing.

Digi has emphasized M2M since the company's inception, a focus that has given it technological dominance and a jump on future competitors. What's more, the stock is now selling at a bargain - it closed at $9.77 on Friday, August 10.

Digi's earnings results for the third fiscal quarter of 2012 disappointed analysts and pushed its stock price down, but secular trends remain in the company's long-term favor. On July 26, Digi reported third-quarter earnings of $2.3 million, compared to $3.6 million in the year-ago comparable quarter.

Third-quarter revenue was $47.6 million, compared with $54.3 million for the same quarter a year ago, a decrease of $6.7 million, or 12.3 percent. Third-quarter operating expenses were $23.2 million, or 48.7 percent of revenue, compared to $22.6 million, or 41.6 percent of revenue, in the year-ago quarter.

Lower revenue in the third quarter resulted from diminished sales of legacy products that the company is now updating for rollout in 2012 and beyond.

Digi's stock is now trading at a price-to-earnings (P/E) ratio of about 26, slightly lower than its industry group, and an attractive valuation in light of its growth prospects.

On March 27, the company announced a partnership with Wind River to deliver Digi's new family of cloud-connected wireless M2M solutions. Dubbed the M2M Solution Builder kits, these offerings will include a combination of hardware, software and cloud connectivity.

Wind River, a wholly owned subsidiary of Intel Corp (NASDAQ:INTC), is a world leader in embedded and mobile software. According to IDC, intelligent M2M systems will account for more than one-third of the volume of all embedded systems worldwide by 2015.

By using the company's products, businesses or government agencies can connect electronic devices from any remote location via a public online connection, Virtual Private Network (VPN), the cloud, satellite network, or cellular carrier.

As mentioned above, one of the company's key offerings is the iDigi Manager, an end-to-end solution that liberates the customer from maintaining an in-house infrastructure. All of the system's components, such as gateways and radio frequency routers, are provided in a ready-to-go, turnkey package. The iDigi Manager is offered on-demand, which means customers only pay for services as they use them, resulting in significant cost savings.

The iDigi Manager is a proprietary and unique system that maintains an account of each device's performance and connection status, making it fast and simple for customers to tap into all information relevant to their subscriptions.

Despite its disappointing third quarter earnings report, I remain bullish on the company, and believe Digi International is a buy up to $14.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.