Pixar Perfect: Toy Story 2 Getting Boffo Box Office

OK, Toy Story 2 is even bigger than Disney (DIS) and Pixar (PIXR) hoped. Now what?

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TS2, the computer-generated animated film produced by Pixar and distributed by Disney, has pulled in more than $80 million in the five days since it was released domestically. Only two films, this year's Star Wars prequel and the 1997 sequel to Jurassic Park, have ever had stronger openings.

With this much momentum, Toy Story 2 is all but certain to break the $200 million domestic box office benchmark that marks a major hit. The only question now is whether the film has the potential to become a Lion King-sized blockbuster. That 1994 animated feature from Disney was probably the most profitable movie ever made, generating $1 billion in income by one estimate.

"It's a great opening weekend," Prudential Securities analyst Kathy Styponias says. "It's a best, best, best-case scenario." (Styponias rates Pixar accumulate; Prudential hasn't done any underwriting for the studio.)

Yet in a classic example of mindless buy-on-the-rumor, sell-on-the-news trading, Pixar shares actually fell Monday. After opening at 49 1/8, Pixar traded down all day and closed at 44 3/16, down 2 7/16. It was trading at 44 1/8 Tuesday. At these prices, the studio has a market capitalization of barely $2 billion.

The drop is probably due to disappointment over Pixar's limited release schedule. The studio won't have another movie out until 2001, and that means the stock is poison to traders until then. Yet what Pixar has accomplished shouldn't be underestimated. Since 1995, Pixar has made three movies. All have been bona fide hits. That record is unheard of in Hollywood, where studios like Fox (FOX) routinely watch dozens of films flop as they pray for hits. And flops that don't get made are flops that don't lose money, which is why Pixar has genuine bottom-line profits. (Fox parent News Corp. (NWS) is a minority shareholder in TheStreet.com (TSCM), publisher of this Web site, and Fox's Fox News Channel televises "TheStreet.com" television show.)

At a Prudential conference earlier in November, Pixar Chief Financial Officer Ann Mather outlined two scenarios for Toy Story 2. If the film pulled in $150 million at the U.S. box office, Pixar and Disney would split $600 million in total worldwide revenue and $250 million in operating profits, Mather predicted. But if TS2 managed to generate $200 million in box office, the partners would split $800 million in revenue. And 75% of the additional $200 million in revenue would go directly to the bottom line, leaving Pixar and Disney to split $400 million in profits.

Mather didn't extrapolate further, possibly because she didn't want to appear overoptimistic. But the math gets even more compelling as the movie gets bigger, because beyond $200 million, Toy Story becomes a cultural phenomenon and generates even higher licensing and home video sales for each dollar of additional box office. Hence Disney's gargantuan profits from The Lion King.

"There's a lot of upside potential [with] high operating leverage in terms of what these films can do," Styponias says.

The question then becomes what Toy Story 2's box office will ultimately be. Unfortunately, neither Disney nor Pixar is willing to make projections, even after the film's successful opening weekend. But there are several handy rules of thumb. The average movie sees its box office decline by about 35% every week and has a total gross of about four times its opening weekend box office. For Toy Story 2, which sold $58 million in tickets between Friday and Sunday, that translates into a total box office of roughly $250 million (including an additional $22 million in tickets the film sold Wednesday and on Thanksgiving).

But that 4-to-1 guide is only an average, and Toy Story 2 is not an average film. The movie got very strong reviews and posted the highest exit polling scores of any Disney film ever, according to the company. Also, animated films generally tend to run longer and stronger than live action films because children like seeing them more than once. Finally, Toy Story 2 has demolished Pokemon and faces essentially no competition for kids and families until late December.

So the $250 million figure is more likely a floor than a ceiling.

"If the current indications are any indication of this film's success, it's going to be one of the biggest animated films of all time, if not the biggest," says Paul Dergarabedian, the president of Exhibitor Relations, a Los Angeles film that tracks box office grosses. "You could make very optimistic predictions about this film, and I don't think you'd be too far off."

Thus the best-case scenario for Pixar and Disney, a Lion King-esque success, suddenly doesn't look so impossible. Again, that translates into roughly $1 billion in pretax profit, split 50-50, or a little more than $300 million in net income for each company. Unfortunately for Disney shareholders, with 2 billion Disney shares outstanding, the Mouse's cut would translate into only 15 cents per share (although even that would be a nice boost, representing almost one-quarter of the profits the company is expected to generate in fiscal 2000).

But for Pixar, which has only about 50 million shares outstanding, $300 million would be rocket fuel, a phenomenal $6 per share in profits over the next 18 months or so. (And unlike, say, 4Kids Entertainment (KIDE), Pixar deserves a healthy multiple on those earnings, since the company has proved it isn't a one-hit wonder.)

Yet it's Disney's stock, not Pixar's, that's gaining. Sometimes investors are hard to figure.

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