Dueling Fools Dueling Fools
Picking on Pixar
November 25, 1998

Pixar Bear's Den
by Bill Barker (tmfmax@aol.com)

Echoing Toy Story's Buzz Lightyear, "To infinity and beyond!" is the usual battle cry of Pixar bulls and, indeed, the price of PIXR has a history of going way, way beyond any rational valuation whenever the company releases a movie. In anticipation of a mega-hit from today's release of A Bug's Life, speculators have pushed PIXR shares to ten times book value, about 75 times next year's expected earnings, over 200 times twelve month trailing earnings, and a market cap of about $2.5 billion.

In attempting to determine whether now is a good time to buy, consider that those who cannot remember the past are condemned to repeat it. When Toy Story came out in 1995, a similar euphoria gripped the market, momentarily pushing PIXR up to $40 a share. What happened next looked remarkably similar to the scene in Toy Story where Buzz realized that instead of being able to fly to "infinity and beyond," he was capable of nothing better than "falling with style" -- which is just what PIXR did (the falling part that is) until finally bottoming out at $11 a share.

Unless a film is a huge hit, there is little profit to be made from it. The recently released 10-Q makes this point clear when it says, "If A Bug's Life is not an extraordinary box office success, the amount of revenue recognized by Pixar will not be significant... resulting in... potentially significant quarterly operating and net losses. Animated feature films that become extraordinary box office successes are rare."

Toy Story, of course, was an Extraordinary Success. The box office champ of 1995 earned between $400-500 million in total profits for Disney and Pixar. Assuming that every future Pixar film is as much of an Extraordinary Success as Toy Story, Pixar's cut of future Extraordinary Successes would be about $200 million, or $130 million after taxes. That's a beautiful return on the approximately $45 million investment that Pixar spends to make a film, but $130 million in profits is still only $2.50 a share in earnings. So at $45 a share, PIXR trades at a Price/Extraordinary Success (P/ES) ratio of just about 18.

Whoa. Pixar is putting out films this year, next year, and maybe in 2000, but not 2001. Assuming that Pixar can put out a film 3 out of every 4 years, the company today is capitalized at something approaching its next 24 years of work. Of course that's assuming that every single one of those films is as big as Toy Story -- the third biggest animated film of all time. I have news for you -- nobody hits nothing but net that consistently. In fact the movie industry daily paper Variety has already declared that ABL won't do the same level of business at the box office as Toy Story did.

Unlike the stampeding herd of Pixar bulls, let's be realistic here about what ABL can do. First, the income streams outside of the domestic box office are a bit more dubious than they were for Toy Story. I just find it hard to believe that toys based on a movie about insects are going to sell as well as toys based upon a movie about... um... toys. So don't count on quite as many kids cuddling up with a stuffed Flik this Christmas as they did with Buzz and Woody in 1995.

As for the foreign revenue stream, Toy Story proved that Pixar does not yet carry the name recognition around the world that Disney has, as it failed to do as much business abroad as at home. Regarding ABL's chances of changing that, consider that foreign box office is even more dependent on star power than the U.S. market. Then think about what exactly the star voice of ABL, Dave Foley, brings to the international marketing table as compared to that of Toy Story 's star Tom Hanks. (Dave Foley, for the 99% of you who can't quite place the name, is on News Radio. For the 60% of you who don't know what News Radio is, it's a sitcom on NBC.) Oh, yeah -- and there's still a recession in Asia to consider, too.

But let's not get bogged down in whether A Bug's Life is going to be a hit. It will be, and that's exactly the danger that potential investors in Pixar face looking at the company today -- confusing the producer of a hit film with a good investment at any price. It's the longer term prospects of animated films, and more specifically Pixar/Disney's animated films that have to panic Pixar shareholders. At the time Toy Story was marketed by Disney, da Mouse was the unchallenged king of the animated film jungle, with the legendary Jeffrey Katzenberg leading the Disney animation unit. However, thanks to a tiff between now ex-Disney exec Katzenberg and Disney's CEO Michael Eisner, Katzenberg's SKG Dreamworks is the sworn lifetime enemy of Eisner, and Pixar is caught right in the middle. For instance, Dreamworks just rushed out a computer-animated film about (of all things) Antz right before ABL hit the theaters. Three weeks from now, Dreamworks' very major animated film, Prince of Egypt, will start cutting into ABL's box office.

Whereas Toy Story came out with no competition, every future Pixar film (thanks to the Eisner/Katzenberg catfight) is now guaranteed a battle. Speaking of computer-animated competition, did I mention that Dreamworks is working on its next computer-animated film? And that Fox is working on one? So, by the way, is Disney itself -- for those of you who thought Pixar had at least locked Disney out of competing with it.

With competition on the rise and Dreamworks, in particular, looming over all of Pixar's future profits, it is likely that no Pixar movie will ever reach the exalted (and needed) box office levels of Toy Story. Considering that, Pixar looks a lot like one bug that's about to be squashed.

Next: The Bull Responds

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