Looks to me like you are not doing anything wrong.
To me it looks like the mesh of the tunnel (the brown brick stuff around the entrance) is not large enough to cover the cut-out terrain.
You can try to cover it up with other objects though, like the "boardwalk" spline or some rock objects.
Forgive me if I'm wrong here, but I think that with this kind of tunnel, with the big tunnel entrance, you don't need to use digholes in the terrain. The dighole is included in the tunnel. Try it without the digholes.
Mick Berg.
What Mick said, try without dighole and the tunnel may have to be placed at right angles to the grid, I think your pic shows more of a 45 angle which doesn't work with some tunnel portals.