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Pixar's Superhero Exploits

By Ronald Grover Anyone who's seen The Incredibles knows how high the animated heroes in Pixar's latest movie hit can jump. Turns out investors hadn't seen anything yet. On Nov. 12, a day after Pixar (PIXR) announced stronger than expected earnings, the Emeryvile, Calif. company took one of those leaps worthy of any caped superhero. By market close Friday, the stock had jumped 8.26%, to $86.54, its highest level since the outfit went public nine years ago.

The big question now, of course, is how much longer Steve Jobs and his muscle-bound computer-animation studio can continue at these heights. Savvy investors might want to strike a cautious note.

No question, the studio, of which Apple chairman Jobs controls 53%, has the most spectacular record in Hollywood, with The Incredibles making it six-for-six monster hits -- from 1995's Toy Story to Finding Nemo last year.

BACK TO THE MOUSE? What set off Wall Street this time was monster earnings, with the company accounting it had earned $22.4 million in its third quarter, or 38 cents a share -- well ahead of last year's 23 cents and above the Street's consensus of 24 cents. Pixar has an "impeccable track record, which is unheard of in the film industry," wrote Fulcrum Global Partners analyst Richard Greenfield just ahead of the earnings announcement. "Successful animation is the product of a great story, and Pixar's storytellers have proven to be better than their peers over a sustained period of time."

Still Greenfield, who began covering the stock in October with a neutral rating, has several concerns about the company, worrying whether Pixar's "perfect record is sustainable." The company is "bound to make a mistake -- every other studio does."

A lot of Pixar's future value, most analysts believe, is wrapped up in whatever kind of distribution deal it makes to replace its current agreement with the Walt Disney (DIS), which expires after Pixar's next film, Cars, due in 2005. In an interview with The Los Angeles Times following the earnings announcement, Jobs said he continues to "get to know other studios," but he also hinted that Pixar might talk once again with The Mouse.

CARVING THE PIE. Disney's board will soon be looking for a successor to Michael Eisner, who has battled with Jobs and plans to retire in 2006. Just the uncertainty of who will distribute Pixar "could increase volatility in the stock and could bound [shares] in the near term," writes Prudential Equity Group analyst Katherine Styponias, who has an $82 target for the stock and a "neutral weight" rating.

A new deal could also increase the risk to Pixar, some analysts believe. Under its current deal with Disney, both outfits share production and marketing costs, with Disney taking a 12% distribution fee. This means Disney gets 62% and Pixar 38% of the profits.

Under any new arrangement, studio sources say, Jobs wants to finance the films himself while giving a smallish distribution fee of perhaps 6% to the studio that gets them into theaters. With $833.2 million in cash on its balance sheet, Pixar has the money to finance several of its computer animated films, which generally cost around $100 million or more to produce.

Still, it's hard to ignore Pixar's string of successful films. Wall Street has bid up Pixar's stock to roughly 21 times projected cash flow, figures Merrill Lynch analyst Jessica Reif-Cohen, significantly higher than the industry average of nine times expected cash flow for 2005.

CHRISTMAS BONUS. Reif-Cohen has a buy on Pixar, with a 12-month target of $95, based on a discount cash-flow analysis that assumes a continued hot streak. Even with a distribution fee of as much as 8%, she figures each film will generate between $200 million and $400 million in free cash flow with the help of huge international and home-video sales. Pixar could add a bonus $50 million, some figure, if it chooses to focus on summertime-only releases. Under its current model, Pixar also releases its films in advance of Thanksgiving, a good time for films, but not as lucrative as the summer, when daytime attendance is higher. Pixar CEO Jobs says the company is contemplating summer-only releases for its next few films.

Merrill's Reif-Cohen estimates that Pixar generated $220 million in profits from Monsters, Inc., an October, 2001, release. But it generated $349 million for Finding Nemo, which was released last summer. The added benefit of a summer release allows for hefty video sales six months later, for Christmas.

As for The Incredibles, it looks like a hit, if perhaps a little less of a hit than Monsters. Reif-Cohen projects it will generate profits of between $74 million and $213 million, even after Disney gets its distribution fee.

Most analysts figure Pixar won't be able to sustain earnings in the $2.20- to $2.50-per-share range many are giving it. That's because many, like Reif-Cohen, don't expect The Incredibles to hit the same revenue heights as Finding Nemo. Sometimes, even superhero studios have a little rest. Grover is Los Angeles bureau chief for BusinessWeek

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