Investors, Beware: Disney
Is Paying Too Much for Pixar


By JAMES B. STEWART
Wall st Journal online, (Subscribed site) 2/1/2006

What's not to like about the Disney/Pixar deal? If ever a match were made in Hollywood Heaven, this would seem to be it.

At a time when most synergies in the entertainment industry amount to little more than wishful thinking, the combination of Pixar's creativity and Disney's marketing prowess has produced six consecutive megahits, from "Toy Story" to "The Incredibles," and has brought billions of dollars in revenue into both companies' coffers. Merrill Lynch analyst Jessica Reif Cohen, not one to gush, called it "a near perfect strategic fit." The market certainly liked the deal, with Disney shares rising on the news, when most acquiring companies see their shares drop.

Disney's proposed acquisition of Pixar, announced last week, is also the happy ending to a great story in its own right: Former Disney CEO Michael Eisner alienates his most important creative partner, Steve Jobs; Mr. Jobs, in a huff, calls off their collaboration and threatens to find a new partner; Mr. Eisner retires early and is succeeded by Bob Iger who renews the courtship and, with great diplomatic skill and finesse, not only woos Mr. Jobs back into the Disney fold, but gives him a seat on the board.
And Disney gets Pixar's creative genius, John Lasseter, and administrative whiz, Ed Catmull, as part of the bargain.

So let's break out the champagne -- and think about selling Disney shares.
I hate to be the one to spoil the celebration. Besides having written a book about Disney, I like the company and have recommended the stock. Disney and Pixar belong together. Bob Iger has pulled off a tremendous feat and deserves credit for it.

There's only one problem.

Disney is paying $7.4 billion to buy Pixar, $1.2 billion in cash and the rest in Disney shares. What's it getting in return? Pixar's most recent balance sheet shows just $1.38 billion in total assets, and $1 billion of that is cash. Pixar shares were trading at an all-time high in anticipation of such a deal, with a forward price/earnings ratio of 51. (Disney, by contrast, trades at a P/E of just under 18, while rival DreamWorks Animation is at 44.) Analysts estimate that the deal, even with the aggressive share buyback Disney also announced, will dilute earnings by about 5% next year and 3% the year after that. And that's assuming the rosy predictions for Pixar's future slate are borne out.

I don't think Mr. Iger had much choice but to pay Mr. Jobs's asking price. If I were in his shoes, I'd probably have done the same thing for the long-term benefit of Disney. I stress "long-term" because in the short term I believe Disney is paying too much, what amounts to over $6 billion for the creativity of the Pixar team, a quality that can be as quixotic as synergy. It's hard to put a price on that kind of asset, but I can't think of a comparable talent deal. By contrast, top Hollywood stars earning $20 million a picture are being paid a pittance.

And it strikes me as unrealistic to expect Pixar to continue its unbroken string of hits. If Pixar never has a failure, then it's not taking any creative risks. As recently as "The Lion King," Disney had such an enviable record, and squandered its dominance. Surely Pixar won't repeat Disney's well-publicized blunders, including turning down the opportunity to buy half of Pixar for $15 million back in the mid-1980s. But I believe Mr. Eisner was right when he predicted that Pixar would eventually produce a flop.
I hope that doesn't happen. I love the idea of a movie about a rat working in a three-star Parisian restaurant, which I hear is in development at Pixar. But at $7.4 billion, Pixar is priced for perfection.

When I recommended Disney nearly a year ago, I saw the prospect for two important positive developments: the end of the Eisner regime and repairing the Pixar relationship. With Bob Iger as CEO, and now the new Pixar deal, both of these events have happened. At about $25.50, which is where Disney was trading this week, the stock reflects the good news. I don't own Disney shares, but if I did, I'm not sure I'd wait around for the years it will take to know if the Pixar deal pays off.

James B. Stewart is a columnist for SmartMoney magazine and SmartMoney.com. Unlike Dow Jones staff reporters, he may have positions in the stocks he writes about. For his past columns, see: www.smartmoney.com/wsj_common.