Microsoft (NASDAQ:MSFT) has been on a roll the past year as everything it touches seems to turn to gold. As a result, Microsoft stock has generated a one-year total return of 57%, almost four times greater than Amazon (NASDAQ:AMZN), its biggest rival in the race to dominate the cloud.
In late October, Microsoft slew the Amazon Web Services dragon, winning the Department of Defense’s $10 billion Joint Enterprise Defense Infrastructure contract. Better known as JEDI, even the staunchest of Microsoft supporters were surprised by the DOD’s decision.
“Most people in the industry were really surprised by this announcement as everyone was expecting Amazon to win the JEDI contract,” MSPoweruser.com stated in October. “This is huge news for the Microsoft Cloud platform. Even though $10 billion is a significant amount of money, the network effect that will be created for Azure through this contract will be more significant.”
Amazon’s Not Happy
However, more surprised by the decision were the people at AWS, who felt Amazon’s cloud offering was superior to Microsoft’s.
“When you have a sitting president who’s willing to be very vocal that they dislike a company and the CEO of that company, it makes it difficult for government agencies, including the DoD to make objective decisions without fear of reprisal. And I think that’s dangerous and risky for our country,” AWS chief Andy Jassy told CNBC in December.
Two months later, AWS is fighting back. On Jan. 22, Amazon reported that it had filed a motion to stop Microsoft from working on the JEDI contract until after the courts have rendered their opinion on the fairness of the DOD awarding Microsoft the contract.
From one perspective, a $10 billion contract over as many as 10 years isn’t a whole lot for two companies whose combined trailing-12 month revenues were a staggering $394 billion; it does seem like a minuscule piece of business, hardly worth fighting over.
However, this is about bragging rights in the cloud space, and more importantly, the business it will bring as a result. While it’s hard to know how many billions in revenue will be generated from other companies and government agencies as a result of the winner carrying out the requirements of this multi-year contract, it undoubtedly will many times the size of JEDI.
The stakes are that high. Hence, Amazon’s latest move. Investors must now wait for the courts to deal with the issue.
Could a reversal hurt Microsoft stock? Yes and no. Here’s why.
Why Courts Overturning Decision Hurts Microsoft Stock
As we sit here today, AWS has a 38% market share in the global cloud market. Microsoft sits in second with 18% market share and Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) sits in third with about 8%. After that, it drops off quite significantly.
The estimate for the global cloud market is expected to grow to $355 billion in revenue by the end of 2022, up from $266 billion at the end of this year. Based on 18% for Microsoft, that translates into cloud revenue of $48 billion in 2020.
Assuming it generates $1 billion a year from the JEDI contract, losing it would reduce its 2020 sales by 2%, nothing more than a blip in its growth. However, more importantly, it could drastically alter the landscape heading to 2022’s projected $355 million in global cloud revenue.
If both companies maintain their level of market share over the next three years, Microsoft would finish 2022 with $64 billion in cloud revenue while AWS would come in at $135 billion.
But as I said earlier, the ultimate winner of JEDI should benefit significantly from future contracts by large businesses impressed by the DOD’s confidence in either of the two.
So, it’s possible that instead of $135 billion and $64 billion in annual cloud revenues from Amazon and Microsoft in 2022, the numbers change, with Amazon picking up an additional 5% market share to $153 billion and Microsoft’s drops to $46 billion as a result of a 5% drop in market share.
In this scenario, Microsoft’s estimate for annual cloud revenues in 2022 would drop by 28%. That not only would be a kick in the teeth for Microsoft, but it would encourage Google and the rest of the large caps trying to capture market share.
Suffice to say, Satya Nadella needs to find some pretty good lawyers to fight this case.
It Makes Microsoft Look Like the Good Guy
Last October, I explored seven reasons to buy Microsoft stock. One of the reasons I listed was CEO Satya Nadella and the job he’s done, making the company relevant again. It has been one of the better chief executive stints in American corporate history.
Once upon a time, Microsoft was viewed as an organization sadly behind the times. Now, it seems everything Microsoft decides to focus on turns to gold. Microsoft Teams being the latest example.
To top things off, Nadella just announced that Microsoft would be carbon negative by 2030. Not neutral, but negative.
”No one company can solve this macro challenge alone, but as a global technology company, we have a particular responsibility to do our part. That’s why today, we’re announcing an ambitious new plan to help address the sustainability of our planet. Today we’re making the commitment that by 2030, Microsoft will be carbon negative,” Nadella stated.
Microsoft’s CEO is leading the charge of companies committed to doing well by doing good. Amazon, by comparison, pays lip service to this kind of thing. For Jeff Bezos to push for a reversal of the contract award, it looks like Amazon is committed to being the poor sport of the two companies.
Whatever happens in this legal battle, I believe Microsoft comes out smelling like roses. If they do lose the contract and the stock drops, I would load up the truck and buy its stock with both hands.
This is a positive, dressed up as a negative. Don’t let it shake you out of your position.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.