Where next for Microsoft’s share price after Pentagon contract stumble?

The tech giant’s share price was recently battered after a US federal judge ordered a temporary halt to a major government contract. Where will Microsoft’s share price go from here?

Last year, Microsoft [MSFT] managed to beat off rivals Amazon [AMZN], IBM [IBM] and Oracle [ORCL] to land a lucrative $10bn technology contract from the US Department of Defense (DoD). Microsoft’s share price has outperformed both major rivals this year too, up 15.4%.

The Joint Enterprise Defense Infrastructure contract, also known as JEDI, would see Microsoft build a cloud platform for the storage and management of sensitive military and defence data from the Pentagon over a 10-year period.

Amazon, which had appeared to be the frontrunner for the work, challenged the decision. A spokesperson blasted the US government for “clear deficiencies, errors and unmistakeable bias” according to the Federal Times. So, what caused the share price to dip?

Last Thursday (13 February), Amazon was cheered when a federal judge approved a temporary motion to have the DoD suspend work on JEDI in response to the lawsuit filed by the e-commerce giant. Microsoft’s share price fell 0.5% from $184.71 to close at $183.71, wiping off $8bn from its market value at the end of the day. At one point during intraday trading, however, the news had temporarily wiped as much as $17bn from Microsoft’s market value in “just five minutes”, according to Business Insider.

Up to that point, Microsoft’s share price had been enjoying a stellar 2020, reaching a record high of $188.70 on 10 February and is up around 15.4% YTD as of last Friday’s close. Over the last 12 months, the stock price has soared nearly 71.4%.

The share price has been boosted by formidable second-quarter results where revenues of $36.9bn and earnings of $1.51 per share easily beat analyst estimates. Its performance was led by strong demand for its cloud computing unit Azure, LinkedIn service and Windows licensing.

So, where will the share price go from here? Will the contract suspension be just a blip on the road to further share price growth or is it the beginning of a correction?

Ramped up antitrust inquiries

“The growth rate for Microsoft will necessarily be tempered simply due to the sheer size of the company. Expect a multiple contraction now that the upside momentum has waned,” Tim Biggam writes in Investor Place. He believes Microsoft’s valuation has been pushed to extremes with a price to earnings ratio of over 34 – the highest in five years.

There is also a potential headache with the Federal Trade Commission’s recent decision to look into the last 10 years of more than 400 acquisitions by major tech firms such as Microsoft and Google [GOOGL] for anti-competitive practices.

“The regulator is now looking at whether a host of smaller deals were designed to snuff out would-be rivals or competitive threats. But the investigation could – and probably should – go further than that because many of the acquisitions made have taken the technology giants into areas that may be tangential to their existing operations or even entirely new. Notable deals here include Microsoft’s $26.2bn buy of LinkedIn,” Russ Mould, investment director at AJ Bell, wrote in a recent note.  

“The technology firms are likely to argue that all of these businesses are interconnected and complimentary to what they already do. They will also be able to point out that not all of the deals worked out. Microsoft took a $7.6bn write-down on Nokia’s mobile phone unit, a sum that exceeded the original $7.2bn purchase price as the strategy here simply failed to work.”

“The technology firms are likely to argue that all of these businesses are interconnected and complimentary to what they already do. They will also be able to point out that not all of the deals worked out. Microsoft took a $7.6bn write-down on Nokia’s mobile phone unit, a sum that exceeded the original $7.2bn purchase price as the strategy here simply failed to work” - Russ Mould, investment director at AJ Bell

Where for next MSFT share price?

The muted share price response suggests that investors are relatively relaxed about the outcome of any investigation. Indeed, the majority of analysts according to MarketScreener still rate Microsoft’s stock a buy, with an average target price of $197.79.

Analysts at Evercore ISI are even more optimistic. They recently raised their target price from $190 to $212. The firm believes Microsoft’s Azure offering will continue to grow driven by its hybrid cloud capabilities, large enterprise footprint and non-conflicted business model.

Microsoft share price vitals, Yahoo Finance, 17 February 2020

“Microsoft has plenty of gas in the tank when taking a multiyear view,” Evercore’s Kirk Materne wrote in a note.

Microsoft is also confident that the JEDI contract dispute will eventually be settled in its favour. “We believe that we will ultimately be able to move forward with the work to make sure those who serve our country can access the new technology they urgently require,” Frank Shaw, Microsoft’s corporate vice president of communications, told CNBC after the suspension.

We will see how the dispute plays out, but Microsoft’s return to relevance — driven by its cloud offering — appears unshakeable.