Also, lawyers and Microsoft combining to call the government a hypocrite? This is like a cesspool of double standards, each trying to be the worst.
The really big problem Microsoft has (and numerous other large US companies that run cloud services with datacenters in the EU, such as Amazon and IBM) is that if they give in with this, there will be lots of EU customers who will leave as soon as possible, and nothing that they'll be able to say or do will stop it short of relocating the company HQ and ownership structure entirely outside the US so the US government and courts really won't have jurisdiction (but will instead have to work through international treaties). This will be caused by the perception in the EU of overreach by the US, and the EU's generally fairly aggressive data protection laws.
At the very least, giving in on this will cost MS a huge amount of money to put right, and there'd be a real danger of an EU competitor being able to grow large enough to lock them out while they're sorting it all out (other US corporations would be in the same position).