DIGI INTERNATIONAL INC (DGII) stock intrinsic value fair value estimate & owner earnings analysis

Digi International sells devices that connect industrial equipment to networks (cellular routers, embedded modules, console servers sold under the Opengear name) and, increasingly, subscription software and services built around them: SmartSense and Jolt for food retailers and restaurants (temperature monitoring, task and label management), Ventus managed network services, and since January 2026 the Particle Industries IoT platform. Manufacturing is outsourced, so the business needs little capital: cash spending on equipment runs only $2-4 million a year. About 80% of sales are in North America. How we measured earnings. We start from operating cash flow and remove the swings in working capital (inventory and receivables moved by $15-26 million in several years, both ways), then deduct stock compensation as a real cost and deduct equipment spending. On that basis owner earnings were $33 million in fiscal 2021, $46 million in 2022, $41 million in 2023, $56 million in 2024 and $66 million in fiscal 2025 (year to September), or $1.75 per share. Adding back the interest the company paid gives the cash the business itself produces before its lenders: about $60 million, $68 million, $71 million and $72 million over 2022-2025. Large amortisation charges on acquired customer lists and technology ($22 million in 2025) are added back because they are not cash costs, but because those acquired assets wear out, we give the business no growth in our base case to account for that decline. Reported net income ($41 million in 2025) understates cash earnings mainly because of that amortisation. Why the earnings level is higher than history. The business today is not the one of 2016-2020, when owner earnings ran $11-29 million. The Ventus purchase (November 2021, $348 million) and later Jolt (August 2025, $146 million) and Particle (January 2026, $49 million) changed its shape, so we measure from fiscal 2022. The median of 2022-2025 is about $69 million of pre-interest cash flow. The first three quarters of fiscal 2026, which include Jolt and Particle, are clearly above that: operating cash flow of $110 million in nine months, revenue up 29% in the June quarter to $139 million, and annual recurring revenue of $191 million. Part of that cash came from a $14 million working-capital release and an $11 million deferred-tax item, so we do not annualise it. We set the base level at $92 million a year, which counts the acquired businesses' earnings but leaves out the unusually strong recent quarters. Owner-earnings growth was 18% in fiscal 2025, mostly from lower interest, and pre-interest cash flow grew only 2%. Our base case starts with no growth in year one, below both figures. Base case, about $28 per share. Pre-interest cash flow holds at $92 million for twenty years, then fades to zero over the following ten. We credit no growth. Revenue excluding acquisitions has been roughly flat since the 2023 peak ($445 million), acquisitions have been large, debt-funded and irregular rather than small and routine, and the acquired intangibles wear out. That leaves the recurring software base and installed hardware customers sustaining today's level, but nothing we can evidence pushing it higher. The business is worth about $1.16 billion. It owes $109 million on its revolving credit line against $28 million of cash, so net debt is $81 million, leaving about $1.08 billion, or $27.74 per share on 38.9 million diluted shares. Bear case, about $16 per share. Industrial hardware demand has cycled hard. Owner earnings fell from $19 million in 2016 to $11 million in 2017, and the 2023-2024 destocking cut revenue 5% while customers worked down inventory. Our bear case starts at $72 million (the fiscal 2025 actual, before the new acquisitions add anything), then puts a downturn deeper than those episodes into years two to four: cash flow drops 35% to about $47 million, recovers over three years, and then shrinks 2% a year as hardware lines age and acquired customer relationships wear away. Earnings power ends after twenty years. The business is worth about $706 million, less $81 million of net debt, leaving $625 million, or $16.06 per share. Even at the trough, cash flow covers interest of about $6-8 million many times over, and the $250 million revolver does not mature until December 7, 2028. Bull case, about $40 per share. The recently acquired Jolt and Particle subscription bases are fully contributing ($110 million a year of pre-interest cash), recurring revenue keeps growing about 2% a year for five years through price increases and renewals, then holds flat for twenty years before fading. That is worth about $1.64 billion, less $81 million of net debt, or $39.96 per share. We left out further acquisitions, management's stated target of higher recurring revenue, and margin expansion, because none of these is in hand today. What could make this wrong. First, the earnings level: if the fiscal 2026 jump comes mostly from Jolt and Particle and costs absorb it, the base level of $92 million is too high, and the true figure is closer to the $69 million median. Second, acquisitions: Digi has spent about $787 million on deals since fiscal 2016, more than twice the roughly $331 million of owner earnings it generated over fiscal 2016-2025. A large, poorly priced purchase funded with new debt or shares would destroy value our cases do not model. Third, tariffs and component costs, especially memory, which management names as a current pressure. Earlier estimates were made on a different measurement basis and are not comparable with these figures. Margin-of-safety price. We are moderately sure of the earnings level: it is backed by four post-Ventus years that cluster between $60 million and $72 million, and three strong quarters since. The worst plausible outcome is a hardware recession arriving together with an expensive acquisition paid for with debt. Leverage is modest (net debt is roughly one year of cash flow), customers are spread out with no dominant buyer, and the balance sheet would survive that combination. If we are wrong about both the earnings level (say $69 million) and growth (a slow decline), the shares are worth roughly $18-20. $15 sits just below the bear case's value, so even that outcome implies no loss of capital. The business yields about $2.35 per share of pre-interest cash a year, or nearly 16% measured against $15, which is close to the 20% target before any re-rating. Movement toward the base case within three years would imply well above 20% a year. The margin-of-safety price is $15.