Microsoft Loses JEDI Deal with Pentagon: Impact on the Stock Valuation and Forecast

Pentagon suddenly canceled a $10 billion JEDI deal with Microsoft (MSFT). The move makes a significant negative impact on the company’s valuations, since investors have priced-in the corresponding revenue and cash flows. The sensational decision arrived on the heels of a lawsuit filed by Amazon (AMZN), and that it is looking to make the two tech giants work together on the job, which is, in our view, an unlikely scenario.

In the announcement closing JEDI project, the U.S. Defense Department said it would now be pursuing a new, multi-cloud, multi-vendor contract for what it calls Joint Warfighter Cloud Capability (JWCC), and it intends to “seek proposals from a limited number of sources, namely both Microsoft and Amazon.” It noted the two companies are currently the only ones capable of providing the Pentagon's needs, although officials would be looking to see “if other cloud service companies could meet its requirements”.

A report from May originally introduced the possibility, with government contracting experts saying the deal with Microsoft was "inappropriate and outmoded" due to its "single-vendor approach." In other words, the originator would have been better off by resubmitting the entire assignment via an open auction rather than inviting a contestant to join the party. In any case, this is bad news for Microsoft.

The JEDI, or Joint Enterprise Defense Infrastructure, was designed to modernize the Pentagon’s information technology (IT). In 2019, officials awarded the contract to Microsoft while rejecting a bid from Amazon Web Services. Amazon then went to court to block the agreement, charging that then-President Donald Trump’s bias against the company and then-CEO Jeff Bezos influenced the decision. Again, regardless of the outcome, this is a lose-lose situation for both.

Bottomline is that yesterday the Pentagon scratched the entire deal, saying because of “evolving requirements, increased cloud conversancy, and industry advances”, the original JEDI arrangement no longer meets its needs. Amazon has twice the valuation multiples of those of Microsoft, and it's shares are more likely to come under pressure of the unknown outcome of the litigation. $10 billion of the lost contract represent around a quarter of Microsoft’s quarterly revenue, so we reasonably expect its shares to fall by 12-12.5% under neutral market conditions.