Pentagon cancels JEDI contract: What it means for AMZN?

The US Defense Department has cancelled the $10 billion JEDI (Joint Enterprise Defense Infrastructure) contract that was awarded to Microsoft (MSFT). Amazon (AMZN) was the other key contender for the contract.

Amazon shares soared to a new 52-week high yesterday after the news while Microsoft shares closed almost flat. It was the first trading day for Amazon under the new CEO Andy Jassy. However, the news of JEDI contract cancellation also seemed to have played a part in yesterday’s price action.

Microsoft had won the JEDI contract

Amazon was widely believed to win the prestigious contract before it went to Microsoft under the Trump administration. President Trump didn’t share a good rapport with Amazon’s founder Jeff Bezos whose Washington Post was critical of the President’s policies. Also, Trump lashed out at Amazon several times for not paying its fair share of taxes and was also critical of the low rates that the e-commerce giant pays to the US Postal Service for shipping.

IBM and Oracle were also interested in the JEDI contract

IBM and Oracle were among the other companies which were interested in the JEDI contract. Meanwhile, the Pentagon has gone ahead and cancelled the contract. It said that it is cancelling JEDI “as due to evolving requirements, increased cloud conversancy, and industry advances, the JEDI Cloud contract no longer meets its needs.”

After Microsoft had won the contract in 2019, Amazon’s AWS (Amazon Web Services), which is the company’s most profitable segment, filed a lawsuit in the US Court of Federal Claims. The company had said that the decision to award the JEDI contract to Microsoft was full of “egregious errors,” which it believed were due to “improper pressure from Trump.”

Microsoft reacted to JEDI contract cancellation

Microsoft blamed Amazon for the cancellation of the JEDI contract and posing a risk to national security. “The 20 months since DoD selected Microsoft as its JEDI partner highlights issues that warrant the attention of policymakers: when one company can delay, for years, critical technology upgrades for those who defend our nation, the protest process needs reform,” said Toni Townes-Whitley, president of U.S. regulated industries in a blog post.

However, it accepted the decision and said “Because the security of the United States through the provision of critical technology upgrades is more important than any single contract, we respect and accept DoD’s decision to move forward on a different path.”

Amazon reacts to the news

Amazon sounded upbeat on the cancellation of the JEDI contract and said “the contract award was not based on the merits of the proposals and instead was the result of outside influence that has no place in government procurement.”

How it could impact Amazon

The contract was valued at $10 billion in absolute dollar terms. In terms of revenues, it hardly moves the needle for both Amazon and Microsoft. Amazon, for instance, has been posting revenues in excess of $100 billion for the last two quarters which is ten times what JEDI would generate in a decade. In 2020, AWS generated revenues of $45.3 billion with an operating profit of $13.5 billion.

AWS generated an operating income of $4.16 billion in the first quarter of 2021 which was almost 47% of the total operating income, AWS is the most profitable business segment for Amazon.

Bezos sounded optimistic about the AWS business during the first quarter 2021 earnings call. “In just 15 years, AWS has become a $54 billion annual sales run rate business competing against the world’s largest technology companies, and its growth is accelerating—up 32% year over year,” said Bezos in the earnings call. He added: “Companies from Airbnb to McDonald’s to Volkswagen come to AWS because we offer what is by far the broadest set of tools and services available, and we continue to invent relentlessly on their behalf.”

Talking of Microsoft, the company has a quarterly revenue run rate in excess of $40 billion. On the face of it, the JEDI contract hardly moves the needle for these mega-cap enterprises, however, it’s more of a matter of prestige for these companies than the money associated with the contract.

Controversies over JEDI contract

The JEDI contract has always been controversial and Alphabet withdrew from the race as the contract did not conform to its ethics guidelines. Oracle, which was vying for the contract, protested against the contract being awarded to one company. It also filed a lawsuit alleging a conflict of interest in the JEDI contract. Oracle said that former Department of Defense official Deap Ubhi has a conflict of interest as he was previously with the Department but later took a position at Amazon.

Pentagon is open to both Amazon and Microsoft

Meanwhile, Pentagon would seek proposals from both Amazon and Microsoft for the new contract. It said in the release that “available market research indicates that these two vendors are the only Cloud Service Providers (CSPs) capable of meeting the Department’s requirements.” It is, however, open to other vendors also and said: “the Department will immediately engage with industry and continue its market research to determine whether any other U.S.-based hyperscale CSPs can also meet the DoD’s requirements.”

Microsoft might have an upper hand

Meanwhile, Mark Moerdler, a senior research analyst at Bernstein, believes that Microsoft is in a better position after the JEDI contract cancellation. “If there is now another competition, Microsoft is going in from a better position,” said Moerdler. As for Amazon, the company will now fancy its chances as the JEDI contract cancellation is coming when the company’s cloud boss is taking over as the new CEO.

Both Amazon and Microsoft shares were trading marginally higher in US premarket price action today as the Nasdaq futures point to a firm opening for US markets today.