FOOL ON THE HILL
An Investment Opinion

Pixar: This Movie Looks Awfully Familiar

By Bill Barker (TMF Max)
October 4, 1999

Shares of Pixar Animation Studios <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PIXR)") else Response.Write("(Nasdaq: PIXR)") end if %> have advanced more than 13% since a two minute sneak preview of the trailer for its Thanksgiving release Toy Story 2 premiered on the Disney and Apple websites on Friday. (The trailer will start appearing in theaters nationwide this Friday.) The fact that the stock has moved up sharply in the wake of the preview's release should come as no surprise to those who have followed this company for a while. After all, this is a stock that has always reacted very dramatically to any news relating to its movie releases.

Pixar is the computer animation company that produced 1995's box office champ, Toy Story, and last holiday season's success, A Bug's Life. Along with being the creator of two of the top five animated hits of all time, Pixar is best known for being the other company that Apple Computers <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AAPL)") else Response.Write("(Nasdaq: AAPL)") end if %> founder Steve Jobs is CEO of. The company came public on November 30, 1995, about a week after Toy Story opened, and shares immediately hit $42 a share on their first day of trading. Despite the fact that Pixar has done, from what I can tell, virtually everything right since then, today's strong price increase merely returns the stock to the level matching its opening-day close of nearly four years ago. (And there's a lesson in that for some of today's IPO investors.)

It should have been obvious at the outset to any investor who was willing to do the math that back in 1995 shares of Pixar could not really have been worth $42 each. Bringing shares public right as its first product was #1 at the box office was a good tactic for a company raising cash, but under the distribution deal that Pixar had with Disney at the time, Disney realized 90% of the profits from each movie. At $42 a share, Pixar was trading at something around 40 times the after-tax profits it would recover (spread out over the next three years) from Toy Story, and at the time the company wasn't ramped up to produce movies anywhere close to once a year. It didn't take long before shares of Pixar were available for $13.

In February of 1997 Pixar renegotiated its distribution deal with Disney. Through the new deal Pixar realizes half the profits from each film it creates, and Disney continues to be responsible for delivering its expertise in marketing the pictures. The new deal dramatically altered the cash that could be realized from each picture by Pixar, and helped temporarily push the stock price up from the mid-teens level at which it had languished through most of the period after the IPO hysteria had burnt off. However, with no film being released in 1997 investors again just couldn't maintain that much enthusiasm in the company, and the price never came very close to breaking $30 a share.

All that changed in 1998, as the market began to bid up shares of Pixar in anticipation of A Bug's Life being a hit on the scale of Toy Story. Actually, the market took the price well beyond what a second Toy Story would have justified, ultimately peaking at $66 a share after the preview for A Bug's Life hit the theaters. The price of shares bounced around a bit, and hit $53 a share just as A Bug's Life was released the day before Thanksgiving. Almost immediately after the release of the film, even though it was a hit right from the start, investor enthusiasm waned, and it wasn't long before the price was back in the mid-30s.

So the company has shown a rather pronounced tendency to move up in anticipation of a new release, and to sell off shortly thereafter, as attention moves elsewhere in the year or more between film releases. This tendency has the unfortunate consequence of focusing some investors' attention on the wrong questions, such as "How high do you think it will move up this time?" rather than "What is this company really worth?"

I took a crack at answering how to value the company on the Pixar message board about eight months ago. It was just an offhand back-of-the-envelope type thing that could easily be improved upon by anyone more interested in taking the time to do a more thorough analysis than what I was offering. I came up with a value of about $40 a share, which (very much by coincidence) is about the price that the stock trades at today.

The analysis that I was doing back then wasn't in any way dependent on how close to release of another film the company was. Such matters really shouldn't change any individual's impression of what the intrinsic value of the company is unless the approach to the release date includes new information that would help to guesstimate what a film's ultimate prospects are. Even then, information specific to one film shouldn't alter the valuation of the company very much -- long-term investors should be more interested in the likely stream of revenues to be recovered from all future films.

Some might argue that it is nearly impossible to predict what a specific film's prospects are, much less a string of not even announced pictures, but I would beg to differ. Pixar has released two films, and in the history of commercial filmmaking, of all the thousands of films ever put out, Pixar has numbers 40 and 41 on the list of all-time worldwide box office champs. That's kind of amazing, isn't it? Supporting the hypothesis that it's no fluke that Pixar's two films are so similar in box-office success is the fact that a number of Disney-animated releases are clustered around Toy Story and A Bug's Life on the list. (Beauty and the Beast is No. 42, Who Framed Roger Rabbit? is No. 45, and Pocahontas is No. 48.) There seems to be a certain amount of gravity being exerted on what a Disney or Pixar-animated film is likely to gross, drawing the final figure toward about $350 million.

I can think of a couple of reasons why Toy Story 2 might do better than Pixar's semi-established level (it has more female characters than the original, there's no animated film competition scheduled for this holiday season, the trailer does look very cool). And there is at least one reason why it might not (sequels very rarely equal the original in quality or box-office numbers). But resolving those questions about a specific film really is of no consequence as to how to value the company as a whole, which should aim to answer, "How are all the future films likely to do on average?" And as to that answer, I would defer to the recorded history as some decent evidence of what to expect.

I don't exactly expect the market as a whole to remain similarly aloof. The manic-depressive behavior that has surrounded this stock from the beginning shows no signs of abating. Still, Fools interested in Pixar as an investment would be well-advised to go through the process of determining for themselves what the value of the company as a whole should truly be. That's a much better use of time than trying to outguess the market concerning where the price will be on the day that Toy Story 2 is released.