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Pixar's rodent problem
Will Pixar and Disney make nice? And is it really working on a new movie about a French rat?
August 3, 2005: 3:13 PM EDT
By Paul R. La Monica, CNN/Money senior writer
Wall Street's bad review: Pixar had been on a tear but shares tumbled following its earnings warning in June.
Wall Street's bad review: Pixar had been on a tear but shares tumbled following its earnings warning in June.
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NEW YORK (CNN/Money) Up until very recently, Pixar Animation Studios enjoyed a stellar reputation with both moviegoers and investors.

That changed in late June when the company stunned Wall Street with an earnings warning due to lower than expected DVD sales of its latest movie, "The Incredibles."

Shares of Pixar (Research) plunged 14 percent the day after the warning and have yet to recover. So as the company gets set to officially announce its second-quarter results on Thursday, investors have to be wondering if this was a one-quarter blip or if Pixar's best days are behind it.

Pixar will first need to address the DVD slump. David Miller, an analyst with Sanders Morris Harris, thinks investors overreacted and that it's a one-quarter problem.

Robert Routh, an analyst with Jefferies & Co., agreed. He thinks there was too much supply too soon, rather than weak demand for Pixar's films. Pixar rival DreamWorks Animation (Research) faced a similar problem this year with the DVD release of its hit "Shrek 2."

Routh said that big retailers have more DVD choices to stock than they used to because of the release of older movies and TV shows. So he thinks media companies will need to tone down the size of their initial DVD releases to avoid flooding the market.

"What this will lead to is Pixar managing supply to meet demand a little better," Routh said. "That won't necessarily mean a reduction in overall copies sold but that there will be fewer shipments initially and it will take a longer period of time to sell that number," he said.

Forget Nemo. Pixar needs to find a partner.

Longer-term, Pixar faces a bigger concern. The company's next movie, "Cars," scheduled for a June 2006 release, is the last film in Pixar's distribution agreement with Walt Disney (Research). Pixar and Disney broke off negotiations to extend their relationship last year.

Currently, Pixar enjoys a sweet deal with Disney. The media giant pays for marketing and distribution of the films, and once Disney recovers those costs, Pixar shares equally in the profits of each film and related merchandise.

It's uncertain if Pixar would be able to negotiate as profitable a deal with another partner. Sony (Research), News Corp (Research). unit Twentieth Century Fox or Warner. Bros., which like CNN/Money is owned by Time Warner (Research), have been mentioned most often by analysts as likely partners if it doesn't make nice with Disney.

Opinions are mixed as to whether Pixar is better off with or without Disney.

Miller wrote in a recent report that since Disney has the sequel rights to the Pixar movies that have already been released, Pixar would be wise to stick with Disney in order to maintain creative control over its popular characters.

"Pixar is just not comfortable with Disney attempting a "Toy Story 3" or "Finding Nemo 2" or "Monsters 2" on its own," he wrote. "Pixar places an enormous amount of importance on character equity and longevity."

But Richard Greenfield, an analyst with Fulcrum Global Partners, thinks that Pixar's DVD woes could worsen if it sticks with Disney. That's because it makes more financial sense for Disney to heavily promote its wholly-owned animated titles than DVDs of movies it distributed for Pixar.

"Disney has the largest animation library competing for shelf space with Pixar titles, so a non-Pixar distributor could help," he wrote.

"Incredible" bargain or more "Monsters" lurking?

There's also the issue of Pixar's pipeline. The company has yet to have a box-office dud. According to Box Office Mojo, a Web site that tracks movie returns, Pixar's six films have grossed nearly $1.5 billion in the United States and more than $3.2 billion worldwide. So the pressure is clearly on Pixar to keep churning out hits.

After "Cars," a buddy movie featuring the voices of Paul Newman, Owen Wilson and Bonnie Hunt, there is little information about what's next on Pixar's schedule.

All the company has said publicly is that its next movie is in production. In its latest annual filing, Pixar said it was set for a summer 2007 release.

But according to numerous movie information Web sites, the movie is tentatively titled "Ratatouille" and will be about a rat living in a fancy restaurant in Paris. The company did not return a call seeking comment about its future releases.

So what's all this mean for the stock?

Miller upgraded Pixar to a Buy after the earnings warning and thinks that a new deal, when announced, will be viewed positively.

Even if the company had to take on more costs to promote and distribute its next few movies, it could probably afford to do so for a little while. Pixar had nearly $876 million in cash and investments as of the end of the first quarter, up from $542 million at the end of last year's first quarter. It also has no debt.

But shares still trade for about 38.5 times earnings estimates for 2005. That's not exactly cheap. So Routh thinks investors would be wise to wait until there is more concrete information about a new distribution deal.

For a look at Time Warner's latest earnings report, click here.

For more media and entertainment stocks, click here.

Analysts quoted in this story do not own shares of the companies mentioned and their firms have no investment banking ties to the companies.

The reporter of this story owns shares of Time Warner though his company's 401(k) plan.  Top of page

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