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Microsoft Wrests Pentagon Contract from Amazon

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Bidding on the 10-year, $10 billion Joint Enterprise Defense Infrastructure (JEDI) project of the Department of Defense (DoD) ended with the government handing Microsoft (MSFT - Free Report) the responsibility of modernizing its tech infrastructure late Friday afternoon.

As in the case of most government contracts, there is an initial guaranteed period of two years (with a million-dollar guarantee), after which there are two renewal options of three years each, followed by another two-year option. So if all goes as expected, as is usually the case, Microsoft will make the promised $10 billion over the stated period.

It hasn’t been easy for Microsoft with favorite Amazon (AMZN - Free Report) in the running, particularly since it had already won a Central Intelligence Agency (CIA) contract for a similar job. But that win may have been its undoing, since the government typically tries to broaden its supplier base.

But Microsoft’s prowess shouldn’t be downplayed either. The company, which was merely a hopeful a year ago, has been building its capabilities and also taking mindshare. So despite Amazon’s surprise at not being awarded the contract, the allusions to unfair process because of personal vendetta between president Trump and Amazon founder Jeff Bezos and Amazon’s statement that it could take the matter to court, everyone knew that Microsoft had a fair chance to win.

It has been head and shoulders above the next contender Alphabet (GOOGL - Free Report) , which dropped out of the bidding process late last year. And although Oracle (ORCL - Free Report) made a public show of outrage that included taking Amazon to court, it was repeatedly pushed back in line. Some also believed that IBM (IBM - Free Report) was in the running, but both these companies lost out earlier this year.

So can Microsoft live up to all the hype? And did it have anything in the first place that the government may have liked?

To answer that, let’s jump to the just-released IDC tech predictions report for the next five years. The research firm sees the hybrid cloud approach as gaining rapid momentum because it helps enterprises connect their private clouds to public capabilities, speeding up their access to flexible compute and processing. This phenomenon will gain traction up to 2022, with 70% of enterprises using management technologies, tools, and processes to facilitate the move.

Microsoft is a front-runner in hybrid provisioning, and has been from the beginning, made the hybrid approach central to its cloud strategy. Moreover, this approach has given it the flexibility to support the DoD in its mission-critical operations. So if the DoD is in a hurry, there’s reason for it to choose Microsoft.

Microsoft has also kept its approach more collaborative than any other player, which means that going with it will allow the government the greatest flexibility to use the best technology from a diverse supplier base.

The DoD’s prior contracts with the company, including the Windows 10 and $1.76 billion enterprise service contracts, may even have supported the decision to go with Microsoft.

The Controversy

Hotly-contested government contracts are sometimes subject to controversy. In this case, it was first Oracle and then Amazon that didn’t consider the bidding process to have been conducted fairly.

Media reports appear divided on the issue because of counter evidences. Some are pointing to a Guy Snodgrass-authored biography of former Defense Secretary James Mattis, where he says that President Trump directed him to “screw Amazon” out of the contract in the summer of 2018. Mattis says he ignored the request.

More damning however was defense secretary, Mike Esper recusing himself from the approval process this September on the ground that his son worked at one of the companies bidding for the contract. It turns out that this company is IBM, which was already out of contention at the time. Not coincidentally perhaps, it was Bezos’ own Washington Post that reported this issue and the fact that Esper’s action followed a White House request to review the contract “after President Trump expressed concerns that the award would go to Amazon.”

DoD chief information officer Dana Deasy also reacted as expected: President or anyone else couldn’t have influenced the team because it was kept anonymous. Further, “Never in my discussions with the deputy secretary of defense or the secretary of defense…did I divulge who the awardee was,” and “To the best of my knowledge,” he added, “no one from the White House contacted any member of the source selection team.”

The U.S. General Accounting Office and the Court of Federal Claims working with a multidisciplinary team of auditors, investigators, and attorneys also was supposed to finish a review by end-November, but has also said that it didn’t find anything wrong in the process.

Conclusion

In the last two years, the DoD has awarded more than $11 billion across 10 cloud contracts. To keep its supplier base diversified is a long-time operating principle of the government. So Microsoft winning here could actually be a positive signal for smaller players.

Moreover, a $10 billion contract over ten years is more a validation of Microsoft’s prowess than a major contributor to its cloud growth story because the market is on track to generate $100 billion this year (Synergy Research) and Microsoft is set to capture around a fifth of that. It does however make it a stronger contender for future government awards, particularly because the government is in the early stages of modernizing.

As far as Amazon’s concerned, the Government Accountability Office (GAO) rules give it 10 days from the date of a contract award, or five days from its official debriefing from the Pentagon, to file a protest and pause the procurement. The subsequent review is to be completed within 100 days. While procurement would normally be halted until the GAO review is completed, the Pentagon is empowered to proceed anyway.

“The challenge for Amazon will be proving that the pressure was applied and proving that the pressure worked,” said Steven Schooner, a professor of government procurement law at George Washington University.

So the clock is ticking.

Recommendation

Microsoft shares carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

 

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