Saying that Microsoft (MSFT) shares are "materially overvalued," Jefferies analyst John DiFucci argued that Azure will probably "never see" the margin broadly expected due to cultural and technical factors. Further, the analyst highlighted that a recent “unprecedented boost” to cash flow from Windows may not persist.

MICROSOFT SHARES 'MATERIALLY UNDERVALUED': Reiterating an Underperform rating on the stock, Jefferies' DiFucci raised his price target on Microsoft's shares to $90 from $80. Nonetheless, the analyst said he continues to believe Microsoft shares are "materially overvalued," contending that evidence suggests that the widely-held assumption that Azure profit will come with scale, similar to how it did for Amazon Web Services (AMZN), is incorrect. Azure will likely never see margins similar to AWS at scale, argued DiFucci, who also thinks AWS long-term margins may be lower than most expect.

The analyst acknowledged that Microsoft "is one of the greatest software success stories in the short history of the sector," but added that Azure will probably “never see” the margin broadly expected due to cultural and technical factors, while a recent "unprecedented boost" to cash flow from Windows may not persist. Overall, DiFucci does not believe the shares’ current price reflects the material risks associated with the major profit center of the company, as he still thinks a significant portion of the profit is driven by the PC ecosystem – primarily the Windows desktop OS business. Meanwhile, the mid-market pie will get bigger in the Cloud domain, but Microsoft’s share of it will go from near 100% to something much lower than that, he contended. In addition, the analyst sees profit margins going lower.

PRICE ACTION: In late morning trading, shares of Microsoft have dropped over 2% to $134.89.