Is Pixar Worth $7 Billion to Disney?

As Disney's (NYSE: DIS  ) board allegedly gathered to consider a buyout offer for Pixar (Nasdaq: PIXR  ) yesterday, the one point that investors can't seem to agree on is whether the speculated price for the computer animation powerhouse -- about $7 billion -- is fair.

It is -- believe me -- but only after you factor in what many seem to be forgetting. For starters, Pixar's balance sheet is flush with slightly more than $1 billion in cash. So a Disney proposal would only cost the family entertainment giant closer to $6 billion if it were an all-cash deal (or help beef up Disney's balance sheet considerably if it was an all-stock deal).

Pixar's six theatrical releases have generated $3.2 billion at the box office and more than that sum in merchandising and DVD sales. This is a high-margin business, too.

However, the biggest mistake that some deal worryworts are making is assuming that Pixar is overvalued -- or that Disney is undervalued -- based on trailing earnings. Yes, Pixar has earned a little more than $400 million over the past three years combined. If you go by the average annual profitability of $134 million at Pixar from 2003 to its projected 2005 take, the air would appear to be a bit thin at the lofty heights of trailing earnings multiples above 50.

But that's not the whole story. Pixar's profits are being understated because Disney takes in half of the film-related profitability and all of the distribution fees. Disney's profit as a distributor is likely in the ballpark of what Pixar makes on the side as a computer animation software developer, so let's call that even. Still, if you add back in Disney's remaining cut of Pixar's success, it translates into a more attractive trailing multiple closer to 26 times earnings.

Still steep? Perhaps, but also consider that Disney's profits would likely have been 4% to 5% lower over the past few years if it wasn't for Pixar (or that much higher if it swallowed the smaller studio whole). Disney has already themed many of its latest park rides and attractions on popular Pixar properties. Disney has the right to do so under the terms of its deal, and that won't change even if Pixar and Disney part ways. Consumers may not understand that, though. In their minds, it may signal Disney's lack of internal imagination, even though the House of Mouse owns the rights to those characters.

Parks license characters all the time. Cedar Fair (NYSE: FUN  ) has Peanuts, and Six Flags (NYSE: PKS  ) has the DC Comics and Looney Tunes stables. There's nothing wrong with that, but it's probably true that Disney would nonetheless get a huge credibility boost if it had Pixar in its fold.

Would Disney be better off by spending half as much to scoop up DreamWorks Animation (NYSE: DWA  ) instead? I don't think so. DreamWorks is a quality outfit, but it lacks the pedigree, history, and perfect batting record that Pixar has accumulated over its 20-year history. It also isn't integrated into the Disney fabric the way Pixar has been over the past decade.

So is $7 billion too much? Let's put it this way: Pixar went public a little more than ten years ago, valued at less than $1 billion. Disney let the years go by -- and the billions in market value accumulate -- without making a play for Pixar. Will passing on Pixar now only introduce the notion of Pixar being overpriced at $10 billion in three years or $15 billion in five years? I don't think new CEO Bob Iger will take the chance of repeating his predecessor's mistake by waiting to figure out the fair price for Pixar while the meter keeps running.

Pixar and DreamWorks Animation are have been winning recommendations forMotley Fool Stock Advisorsubscribers. Cedar Fair was singled out last year for readers of theIncome Investornewsletter. For a 30-day free trial subscription to the newsletter of your choice, click here.

Longtime Fool contributor Rick Munarriz is still a kid at heart, smitten with the right kind of animation. He owns shares in Disney, Pixar, and Cedar Fair.The Fool has a disclosure policy. Rick is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.


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