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Amazon Asks Court to Pause Microsoft’s Pentagon Cloud Contract: Should Investors Be Worried?

By Donna Fuscaldo - Jan 28, 2020 at 2:41PM

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Amazon wants Microsoft to stop work on the Pentagon's $10 billion JEDI cloud computing contract until its lawsuit is settled.

Amazon (AMZN 4.03%) says it isn't willing to give up on winning a 10-year, $10 billion Pentagon cloud computing contract it lost to Microsoft (MSFT 1.29%) last year. The Pentagon says Microsoft won it fair and square, but Amazon doesn't agree. The tech giant claims political bias and last week it asked a U.S. federal court to stop the deal from moving forward while it works to settle a lawsuit over how the deal was reached.

Last Wednesday's court filing sent shares of Microsoft down in after-hours action, as investors worried the software giant could lose the lucrative and door-opening contract. After all, as a distant second-place player in the cloud computing market, Microsoft has a lot more to lose than Amazon Web Services (AWS), Amazon's cloud computing segment.

Here's what this latest development means for Amazon and for Microsoft.

Several computers connected to the cloud.

Image source: Getty Images.

How and why the JEDI contract was awarded is in dispute

In its latest salvo, Amazon filed a motion in the U.S. Court of Federal Claims saying that, while it supports the government's efforts to digitize its systems and consolidate its cloud partners, the process of awarding it needs to be reviewed. It filed a lawsuit in November, arguing Amazon lost the bidding because President Trump viewed Amazon CEO Jeff Bezos as a political foe.

The Joint Enterprise Defense Infrastructure (JEDI) cloud contract is aimed at modernizing the technology systems and consolidating cloud computing across departments in the Defense Department. Because of Amazon's Central Intelligence Agency cloud contract and its leadership in the market, Amazon was expected to easily win the new deal.

But that expectation changed in August 2019 when the White House reportedly began examining Amazon's bid. A few months later, the contract went to Microsoft, which sent its shares surging. 

Much of Microsoft's rebirth in recent years has to do with its cloud computing business, which has been driving double-digit growth. Investors tend to react favorably when it wins big contracts, especially at the expense of Amazon. Likewise, they react negatively if there are any hiccups in the business. For its fiscal fourth quarter, Microsoft's cloud computing sales were up 27% year-over-year, driven by a 59% increase in its Azure cloud sales. 

The Pentagon contract bolsters Microsoft's street cred

Sure, Amazon is the leader in cloud computing, but Microsoft is slowly showing itself as an able competitor. Winning the JEDI contract was a huge boost for its cloud business, giving Microsoft's cloud offering much more validation. That validation can open doors for Microsoft in and outside of the government. In order to get more cloud customers, Microsoft has to show its technology is equal, if not superior, to Amazon. 

While Amazon claims Microsoft only won the contract because President Trump doesn't like its CEO, Microsoft argues that its hybrid approach to data storage is what closed the deal. Microsoft realizes customers don't want their cloud provider hosting all of their data, and enables clients to embrace a hybrid approach, with some of the data residing on-premise and other data in the cloud with Microsoft. 

The contract is also important for both companies' growth. Amazon won't miss the $10 billion over 10 years, but in order to expand its cloud businesses, Amazon and Microsoft need the government. The government's systems are massive and in need of an upgrade. Winning contracts in one department makes it much easier to win them in another department.

Microsoft is undeterred by Amazon's posturing 

Despite the legal maneuvering on Amazon's part, Microsoft is undeterred. It has kept its head down and focused on the work at hand with the Pentagon.

Through its President Brad Smith, Microsoft has been pushing back on Amazon's claims that its technology is far superior to Microsoft's cloud offering. Smith argues that Amazon is naive to believe that it's too far in the lead to ever lose a technology race.

Microsoft bulls also aren't too worried about losing the contract to Amazon. Amazon will have to prove the Pentagon chose Microsoft because of political bias to win the case, which is likely to be an uphill battle.

If Amazon loses the case, Microsoft investors can breathe a sigh of relief. It means more business from the federal government is likely to come Microsoft's way.

But if it does turn out Amazon can prove the White House was biased, investors should brace for a decline in shares of Microsoft, even if it's short-lived.

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