An Unexpected Scandal Threatens To Cripple Amazon

Submitted by Grant's Almost Daily,

Amazon.com, Inc.’s Web Services (AWS) unit has been the engine behind the company’s spectacular recent performance, with operating income of $7.2 billion last year, up 68% year-over-year and accounting for 59% of Amazon’s total operating income. The near-consensus cadre of bullish analysts (48 out of 50 tracked by Bloomberg have a “buy” rating on Amazon) call for more of the same.  But will an ongoing government kerfuffle derail the AWS miracle?  

Last Wednesday, the Department of Defense (DoD) cleared itself of wrongdoing following an internal investigation into the forthcoming award of the $10 billion cloud computing Joint Enterprise Defense Initiative (JEDI) program. Yet the Pentagon’s self-exoneration was not comprehensive, as Bloomberg noted that: “The investigation uncovered evidence of unethical conduct that will be referred to the DoD inspector general for a separate review.”

The JEDI contract has been hotly contested among some of the largest cloud-computing companies in the U.S., and for good reason. The winner-take-all award has been narrowed to two contenders, AWS and Microsoft Corp. According to an updated timeline issued by a Federal judge Tuesday, the JEDI mandate will be awarded sometime after mid-July. 

With the stakes high, Uncle Sam’s corporate suitors are pulling no punches. In December, recently-eliminated Oracle Corp. filed suit with U.S. Court of Federal Claims asserting that the JEDI process has been marred by conflicts of interest.  The suit alleges that a pair of Amazon-connected former DoD staffers unduly influenced the proceedings in favor of AWS. One of whom, Deap Ubhi, worked in business development at AWS from 2014 to 2016 before joining the DoD, during which period he continued to praise Amazon from his Twitter account (including tweeting “once an Amazonian, always an Amazonian” in January 2017) while criticizing Oracle, Alphabet, Inc.’s Google and other Silicon Valley firms. 

According to an April 5 report by The Capitol Forum, in January 2017 Ubhi lamented missing a conference call between Defense Department officials and AWS personnel, writing via email: “I am ex-AWS, and would have liked to have been on the call.” Eight months later, when acting as the DoD’s lead JEDI project manager, Ubhi asked DoD higher-ups to name him “the point of contact for all industry conversations.” After reportedly recusing himself from the JEDI procurement process in late October, Ubhi left the DoD, returning to AWS in November 2017.

In March, the Federal News Network reported that the FBI is involved in the DoD inspector general investigation, potentially signaling “some sort of wrongdoing involving DoD civilian personnel and/or DoD procurement procedures.”

In addition to Ubhi, other former DoD officials have seen their actions around JEDI come under scrutiny. In August, Vanity Fair reported that Sally Donnelly, a former senior advisor to Secretary of Defense James Mattis from January 2017 to March 2018, “sold her stake in [consulting firm] SBD Advisors, LLC for $1.17 million two days before she went to work for Mattis.”  But Donnelly continued to receive payments from the company, which counted Amazon as an active client. Two weeks after Donnelly left the Pentagon, SBD was purchased by C5 Capital, “a private equity firm with direct ties to Amazon.”

Anthony DeMartino, Donnelly’s colleague at SBD, who was also named in the Oracle lawsuit, likewise consulted for Amazon before moving to the DoD to serve as Mattis’ deputy chief of staff. 

The close proximity of Donnelly and DeMartino to the Secretary of Defense was a favorable development for AWS, as The Capitol Forum reported on March 15 that Mattis “expressed interest in meeting with Amazon CEO Jeff Bezos at a dinner” with Donnelly in early 2017, according to emails received via a Freedom of Information Act request. Mattis and Bezos met in Seattle in August 2017. 

As controversy over JEDI continues to swirl, another government agency pivots away from the winner-take-all format. On March 22, the CIA unveiled a new Commercial Cloud Enterprise (C2E) initiative, in which the agency disclosed plans to use “multiple commercial cloud vendors that can provide” necessary services. 

An anonymity-seeking, D.C.-based source believes that the CIA’s move might suggest wider government dissatisfaction with AWS, which commanded 46% of worldwide public cloud infrastructure market share as of year-end 2017 according to the International Data Corporation:

The AWS story, as sold to enterprise customers and the Street, is built upon the intelligence community (IC) reference case and the cash that has come in from that deal. The IC’s movement toward a multi-cloud environment is an admission that use of AWS has not been successful as claimed, increasing the likelihood of massive IC contracts for the other hyperscale cloud providers. 

Amazon.com, Inc. ten-year stock price, 37% compound annual growth rate. Source: The Bloomberg

Continued cloud dominance is crucial to sustaining Amazon’s success. Analyst consensus calls for Amazon’s net income margin to jump to 6.4% in 2019 from 4.3% a year ago, thanks to expected growth in AWS.  But at the same time, the core e-commerce business is showing signs of a slowdown, as Bloomberg estimated last week that gross merchandise volume growth fell to 19% last year from 24% and 27% in 2017 and 2016, respectively. 

While the C.I.A.’s move toward multiple cloud vendors highlights the difficulty in growing AWS’ commanding public cloud market share, legal risks surrounding JEDI represent a potentially underappreciated pitfall to the AMZN bull case. Our D.C.-based observer concludes:

If AWS is found to have committed wrongdoing related to DoD’s JEDI contract, it could be debarred as a government contractor. My prediction: Amazon bulls expecting continued blistering growth from AWS will be in for disappointment. 

Asked for comment on Thursday afternoon, Amazon had not responded by press time.