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VMware shares to surge more than 20% because the Amazon cloud threat is overblown: Analyst

Lluis Gene | AFP | Getty Images. Deutsche Bank admits VMware’s software business can continue to thrive in a cloud-computing world.

Wall Street rarely talks about its mistakes, but Deutsche Bank admitted it overestimated the Amazon (NASDAQ: AMZN) Web Services threat to VMware's (NYSE: VMW) business.

The firm raised its rating for VMware shares on Monday to buy from hold, saying the company's server virtualization software can continue to thrive in a cloud-computing world.

"We've spent much of the last two years worried about VMware's on-premise core server business given its maturity and the threat from AWS/Cloud adoption [Amazon Web Services]," analyst Karl Keirstead wrote in a note to clients entitled "Overcoming our AWS fears."

"This upgrade should be seen in the context of growing evidence that large enterprises are embracing a hybrid model, materially lowering the out-year risk profile of VMware shares."

The hybrid model is defined by companies using both local servers on-site and cloud-computing servers off-site. Keirstead said he realized the staying power of VMWare's on-site server market was more "durable" than he originally forecast.

"We believe that large enterprises are migrating IT workloads to the public cloud model at a slower-than-expected pace and are electing to ramp spending to modernize their on-premise IT infrastructures," he wrote. "Our recent checks agree that VMware technology is proving to be more durable than they would have thought 12-18 months ago."

As a result, Keirstead increased his VMware price target to $120, which is 24 percent higher than Monday's close. His previous price target was $110.

VMware shares are outperforming the market this year. Shares have risen 23.2 percent year to date through Monday compared with the S&P 500's 8.5 percent gain.

The analyst said he is also cautiously optimistic about the VMware and Amazon AWS strategic partnership announced in October, which enables access to AWS computing power for the company's customers.

"We are positive on the deal for both parties. It is hard to imagine how this could end up being a net negative for either party," he wrote. "We conclude that the stock can still work even if the initial lift from VMware Cloud on AWS is modest."

VMware will report second-quarter earnings on Thursday after the market close. Its stock traded up 1.8 percent short after Tuesday's market open.

— CNBC's Michael Bloom contributed to this story.

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