Last week, the U.S. Army announced that it had finalized a $21.9 billion deal to have Microsoft (NASDAQ:MSFT) provide 120,000 augmented-reality (AR) headsets for its troops over the next 10 years. Investors have responded enthusiastically, bidding Microsoft stock up by more than 7% since the announcement.

But what will this deal really mean for Microsoft? 

A man wearing AR glasses that is also touching the rim of his glasses.

Image source: Getty Images.

The deal

The contract is worth upwards of $21.9 billion and could see Microsoft sell the government more than 120,000 headsets based on its HoloLens 2 hardware. The deal is good for an initial period of five years with the option for the Army to renew it for another five years. This means that some portion of that $21.9 billion in revenue may not be guaranteed, but as long as Microsoft holds up its end of the deal, it's unlikely the government will back out five years in and go through another arduous implementation process with a different vendor.

So what is the HoloLens 2? It is Microsoft's AR headset built for enterprise customers. The standard headset goes for a whopping $3,500 with premium versions costing upwards of $5,000. Assuming the deal is for 120,000 devices as the rumors say, that would mean the government is paying $182,500 for each unit. That's a huge price bump, but the HoloLens 2 will only be the core of what the military is asking for -- an Integrated Visual Augmentation System (IVAS). The company will be making the systems more rugged and adding a lot of custom hardware and software features on top of the standard model, such as thermal and night-vision sensors.

Government contracts can carry complications

This isn't Microsoft's first contract for the Department of Defense. In late 2019, the company was awarded the $10 billion JEDI cloud contract to provide cloud computing services to the Department of Defense, a huge win over rivals Amazon and Alphabet. However, that contract is being held up in court as Amazon has sued to challenge the award, accusing former President Trump of influencing the decision due to a bias against the e-commerce company and its founder and CEO, Jeff Bezos. 

Whatever the outcome of the JEDI litigation, Microsoft has a solid footing and the potential to bring cloud services to the U.S. government while also integrating those services with tens of thousands of augmented-reality devices. Plus, if Microsoft lives up to the government's expectations, it may have a leg up when new cloud, software, and hardware contracts come up in the future.

What it means for the stock

While $10 billion and $22 billion deals would be large figures for almost any other company, these deals won't move the needle significantly for Microsoft. The company generated $153 billion in the past 12 months, so an additional $32 billion spread out over a decade won't exactly be game-changing.

However, the augmented-reality contract could be an important stepping stone if it helps build momentum for mainstream AR adoption in other industries like healthcare, construction, or manufacturing. Remember, each HoloLens 2 costs thousands of dollars, so for every million headsets that Microsoft sells, that is billions in new revenue flowing to the top line, before counting any software add-ons.

Facebook, Apple, and other companies might eventually duke it out for dominance in the consumer segment of the AR and VR (virtual reality) markets, but Microsoft looks to be all alone out front when it comes to enterprise and work-based AR. 

Overall, investors should be happy with this Defense Department contract and the momentum it could build for Microsoft's future business. The deal has the potential to springboard its AR devices into the mainstream, adding another pillar to Microsoft's cloud, software, and hardware ecosystems. Even with the shares hitting all-time highs and the company's market cap at a remarkable $1.9 trillion, there's no reason to sell Microsoft stock anytime soon. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.