Well, that is a bummer.
Steps 1,2,3 as you explain sound normal. Except the last step. I’ll explain.
I offer the following, and sorry if it sounds like obvious stuff you may have tried:
First, if you are logged in as the SuperAdmin aka NetworkAdmin, you will still be able to browse inactive blogs. It is normal to click activate while logged in as the SuperAdmin and be directed immediately to the blog – and see it as if it were all normal. However, try logging out of SuperAdmin when visiting the flagged blog waiting moderation. SuperAdmins see all blogs, deleted, spam, archived, mature, the lot. Everyone else will have their blog viewing interrupted when landing on a flagged blog.
Second, if logged in as a lesser peon, or not logged in at all, you should not see any blogs flagged as inactive(deleted, spam, archived, mature, or etc.). You should see a “This site has not been activated yet. If you are having problems activating your site, please contact me AT my.domain.”
Third, are the blogs you create flagged with “Awaiting Moderation” in the NetworkAdmin->Sites? Look for your newly created site row, and under the column “Actions”, you should see “Awaiting Moderation”.
I still use this plugin regularly, and it works with all the latest core WordPress code 4.4.2.
Only other thing I offer is the possibility of conflict with other plugins or modifications to the default signup/activation process.