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									     Case Study: Valuation of Pixar Animation Studio
     Introduction
             The financials of Pixar Animation Studio were looked at and studied. A valuation
     of the company based on its financial data will be presented in this report. Pixar is based
     in Emeryville, California, its stock symbol is PIXR, and the financial information is
     current up to February 2, 2004.

            After Pixar decided not to resume its production partnership with Disney, one
10   which had historically been very successful and very lucrative for both companies, it
     seemed that it would be important to see how well off financially Pixar is on the short
     and how well they would be in the long run as so to determine the rationality of this
     decision to part with their big brother in film production, Disney.

             The format of this report will go like this. We begin with a quick introduction to
     the valuation method that will be used to appraise the company, then a brief discussion of
     the market conditions of the National economy and the movie industry. We will then go
     into the financial statements of Pixar and also the valuation calculations. Lastly a look at
     what the valuation estimates tell us about the company and how its present and future
20   finances look.

     Valuation Approach
             Discounted present values of proforma cash flows will be used because we wish
     to see the present values of future earnings based on the growth rate of Pixar. This report
     also will look at some other businesses in similar enterprises as well as financial strength
     to evaluate how Pixar stands in relation to other businesses in the same category.

     Sources of Information
             The first source of financial information was obtained from the annual report for
30   the fiscal year of 2002 released by Pixar. This was a source of Income Statements,
     Balance Sheets, Cash Flows, financial information discussion, and history of the
     company. Next to find some data for the company that reached back further, the UC
     Davis GSM’s Compustat account was queried for the data. Also Yahoo! Investor,
     Reuter’s Online websites provided digital versions of the data to feed into a spreadsheet.
     For comparisons to other companies, the Risk Management Association’s (RMA)
     publication titled Statement Studies, 2003-2004 under “Motion Picture and Video
     Production.”

     Appraisal of Market Conditions
40   The National Economy
            The US economy seems to be going through a slow-paced recovery. Looking at
     some figures ranging from Sept 2003 to Feb 2004 we see that Unemployment has
     decreased from 6.1% to 5.6%, Average Hourly Earnings have gone up from $15.41 to
     $15.52 and the Consumer Price Index has risen from 0.3 to 0.5 (Jan 2004 data, Feb 04

     Pixar Animation Studio Valuation                                                    Page 1 of 8
     unavailable). We can view this as small growths in the ability for consumers to spend and
     also that prices are rising as well.
     [Data obtained from the US Bureau of Labor Statistics http://www.bls.gov ]


     Appraisal of the Movie Industry
50           Since 19921 there has been a rise in the box office takes every year, setting new
     records with each movie season. The year 2003 itself generated $9.5 billion in sales
     revenue. Movie sales are somewhat immune to economic troubles because their relative
     low cost and inherent demand caused by consumer expectation. However a more
     favorable economic climate can always be beneficial. The rise in sales is not completely
     or mainly attributed by higher number of sales but rather an increase in the ticket prices at
     many theaters. Regardless, the revenue generated from movies appears to be steadily
     increasing which bodes well for the industry as a whole and can be especially good news
     for a company that has a perfect record with box office success.
     1
         Marketresearch.com (http://www.marketresearch.com/land/product.asp?productid=952538&progid=1906)
60
     Competition in Family Films
             In the realm of family movies, Pixar’s biggest competitor is also its best ally,
     Disney. While the two studios may not continue to operate together in their partnership,
     they are still joined together economically under a contractual agreement that will
     continue on to Pixar’s next two theatrical releases. Under this agreement, the studios have
     worked out a way to release their respective films without cannibalizing each other’s
     movie sales.

              Although a pioneer, Pixar is no longer the sole producer of theatrical length and
70   quality computer animated films. Competitors in this niche production have thrown their
     hats the computer animation ring. The film “Shrek” was a major indication that Pixar was
     not the only show in town. Produced by DreamWorks SKG, the film was successful both
     critically and commercially, earning over $266 million in the theatres and over $30
     million in home video sales. Other companies include Blue Sky Studios, a company
     owned by Fox, which produced the also well received movie “Ice Age.” Rounding out,
     there is also Walt Disney’s computer animation wing and Lucasfilm, which did the CGI
     for its own Star Wars flms.

     Conclusion
80            In 2003, Pixar was situated in a interesting position because release of 2003,
     Finding Nemo had great market success because of consumer expectation and the lesser
     competition in the family movie market, and well it was a very well done movie,
     critically acclaimed and had great reviews. Although its competitors have been able to
     replicate both Pixar’s technical ability and to some extent, Pixar’s success, they have
     quite a ways to go, if they want to unseat this market leader.

     Fundamental Position of Pixar
     Background
           In 1984, Pixar began as the computer graphics division at George Lucus’
90   LucusFilm. Two years later in 1986, Steve Jobs of Apple Computer purchased the

     Pixar Animation Studio Valuation                                                                       Page 2 of 8
      business and established Pixar as its own company. During the growth and maturation
      period of 1986 to 1994, Pixar produced a number of small computer animated shorts,
      some unique computer generated commercials, and developed software tools that are
      widely used throughout the computer graphics industry.

              The year 1995, was a breakthrough year for Pixar because this was the release of
      its movie Toy Story which was marketed and distributed by the Walt Disney Company.
      This was also the year when Pixar began to publicly sell their stocks and it was a hotly
      traded IPO, becoming the largest selling IPO of that year. Its commercial success of Toy
100   Story was followed by critical accolades as well as recognition in which the film received
      an Academy Award. As a result of these achievements, Pixar was able to obtain a more
      favorable agreement with Walt Disney Company in which the revenues were equally split
      between the companies less some distribution costs for Disney and other smaller
      agreements. This lasted for 5 feature films beginning with A Bug’s Life and will end with
      Pixar’s 6th film, Cars. Its most recent film, Finding Nemo, released in 2003, was an
      immensely successful film following a string of 5 record setting movies.

      Management
             Steve Jobs of Apple Computer fame serves as the Chairman and CEO of Pixar.
110   Rounding the out the top, Ed Catmull is the President, Ann Mather has the role of
      Executive Vice President and Chief Financial Officer, Lois Scali is the Executive Vice
      President and General Counsel. Continuing on, John A. Lasseter has the title of Executive
      Vice President of Creative and lastly Sarah McArthur has the authority of the Executive
      Vice President of Production.

      Trend Analysis
              Income Statement. Table I has a four year snapshot of Pixar for the span from
      the year 2000 to the year 2003. Sales have gone up from $172 million in 2000 to $262
      million in 2003. During this span, the growth rate was an average of 50.1% and there was
120   a decline in growth between 2001 and 2002 of -59.24%.

             Gross margin has also grown considerably, beginning at $135 million in 2000 and
      ending at $224 million in 2003. Also during 2001, there was a much smaller gross of $57
      million. This can be explained by absence of a movie released in 2000, instead revenues
      came from home video sales and capital investments geared towards Pixar’s new
      Emeryville headquarters.

             Looking at operating expenses relative to sales it seems that Pixar’s operating
      expenses have been fluctuating throughout the period from 2000 to 2003. A possibly
130   explanation for this would be the cycle of production and releasing of new films. In years
      where a Pixar film is released, it is expected that this percentage would be higher.

              In general earnings before interest and taxes has held steady, going no lower than
      77% and no higher than 80%. Next, taxes have also been at around the same corporate
      level bracket of around 30%. It is notable that in 2001, Pixar was taxed at a lower amount
      because of research that Pixar did which had some federal benefit. Net income has been

      Pixar Animation Studio Valuation                                                  Page 3 of 8
      rising, but as a percentage of sales, has remained mostly under 50%, with the exception
      of 2001 in which net income was 51.6% of sales.

140   Conclusion
               The income statement tells us that Pixar is a healthy vivacious company, who’s
      ability to make money seems to grow with each new theatrical release. Its average growth
      rate during this period of just over 50% is very strong and its high rate of profitability is
      also indicates this as well.

              Balance Sheet. Table II shows the same four year range as the income statement.
      Looking at the most recent year 2003, cash and investments seem to be Pixar’s largest
      share of assets, amounting to 52.14% of the total assets of the company. For the 2003
      balance sheet release, the category of cash could not be separated from investments as in
150   previous years because of their choice in reporting. Therefore looking at cash and
      investments as a whole, Pixar has consistently had a high percentage of this, from around
      40% to about 50%. As a movie production company, it can be inferred that many of
      Pixar’s current assets are put into the investments which go to produce films, therefore
      this percentage is high. Most of the rest of the current assets lies in receivables. Much of
      Pixar’s receivables comes from Disney which under their contractual agreement,
      reimburses Pixar for the costs of producing the films and distributes profits from those
      movies to Pixar.

              Under the category of land in fixed assets Pixar does not have much to report,
160   probably because it is under a lease for its offices. Plant and equipment are the largest
      parts in fixed assets where they were 23.11% of assets in 2000 and 11.49% of assets in
      2003. Capital investment into its Emeryville headquarters around 2000 probably would
      explain the higher percentage and continuous spending on new production equipment
      would explain why this is the highest figure in fixed assets. Intangible assets also
      compromise a significant percentage of total assets with 11.89% in 2000 and 10.76% in
      2003. Intangible assets for Pixar can include characters from its films with it shares with
      Disney to produce merchandise.

               The liabilities that Pixar carries are relatively low relative to the stockholder’s
170   equity. Total liabilities in 2000 were 9.15% of the total liabilities and stockholder’s
      equity and in 2003, total liabilities were even smaller, 6.04%. This can be explained by a
      rise in the value of the company’s stock and an increase in retained earnings and a
      lessening of liabilities as well. In 2003, accounts payable was less than $2 million while
      in 2000, accounts payable was over $28 million. The 2000 accounts payable figure is also
      probably including major costs from its capital investments therefore it is probably not
      comparable to the other figures which all float around $2 million to $5 million.

      Conclusion
             From the balance sheet, we can tell that Pixar has large amounts invested in its
180   production and has a considerable amount of cash in reserve as well. Also, its
      stockholder’s equity is in most cases, almost 9 times greater than its liabilities.


      Pixar Animation Studio Valuation                                                    Page 4 of 8
               Ratio Analysis. Table III holds the calculated ratios for the years 2000 to 2003.
      The case of Pixar, there is no inventory primarily because Pixar produces its movies at a
      low volume and therefore the current ratio and the quick ratio give exactly the same
      number. Current ratios indicate the liquidity of the company, how well it is able to pay
      off debts in a hurry. Since the current ratios for Pixar have all been high than 1, in 2002 it
      was 25.77 and currently 2003 it is 12.02. Leverage shows Pixar to have little debt relative
      to total assets with a ratio of 0.09 in 2000 and even less with a ratio of 0.6 in 2003.
190
              Total asset turnover has remained under 1 and has held pretty consistent.
      Although Pixar has large figures for sales, it also has even larger numbers for assets. For
      2003, the total asset turnover was 0.26 indicating that $0.26 was generated for every
      $1.00 from assets and this was a little higher in 2000, with a ratio of 0.36. In this category
      of activities, Pixar does not show too much interesting information because it has an
      inventory of 0.

              Arguably the most important ratio measure would be the profit margin. The profit
      margin shows how much of sales results in profits after the costs are taken out. In Pixar’s
200   case this was 78% in both 2000 and 2003. This is quite a large percentage as it infers that
      their costs and other factors result in 22% of the sales. Put it in another way, the can take
      home more than three-quarters of the sales after subtracting out the amount they spent to
      get the sale.

      Conclusion
            Through the ratios, we can see that Pixar has maintained high liquidity, small
      amounts of debts, and high profitability.

      Comparative Industry Analysis
210           In Table IV, we have a listing of Risk Management Association’s (formerly
      Robert Morris Associates) data from its publication Annual Statement Studies 2003-2004
      found under the category of “Motion Picture and Video Production” and companies with
      asset size in excess of $25 million. The calculation of ratios performed by RMA maybe
      be slightly different from the methods used to valuate Pixar, they still should be
      comparable. Also notable is that Pixar is actually a billion dollar company in terms of
      assets as of 2003 while many of the companies sampled in the RMA report are probably
      around the area of $25 million to maybe $75 million or $100 million. There is a large
      discrepancy in asset size that exists here.

220           We first note that Pixar has a similar percentage of cash & equivalents for 2000
      but has significantly smaller percentages in the follow years after that. For 2003, there is
      no value because a separate cash amount cannot be determined at this time. Other similar
      percentages include Trade receivables, where the RMA sample is at 30.6% and Pixar’s
      numbers hover at around 20%. Also net Fixed assets are 18.1% for RMA and 17.27% for
      Pixar in 2000 but they grow to much larger after 2000. Possible explanations could arise
      from capital investment causing this.



      Pixar Animation Studio Valuation                                                     Page 5 of 8
              Looking at liabilities, we see that Pixar has much lesser liabilities in almost every
      category than the average of these companies. Notes payable was 15.1% for RMA and
230   the highest notes payable for Pixar was 5.94% and the subsequent years after are all less
      than 1%. Pixar’s net worth is almost 10 times greater than the RMA value of net worth at
      9.5%.

             Operating expenses for Pixar are much less than the RMA companies, in this case
      the operating expenses for the RMA sampled companies is ten times more than the
      expenses for Pixar. Accordingly the operating profit for Pixar is much more and the EBIT
      percentage is around 80% while the RMA is 3.30%.

               Starting with the current ratio, we can tell that Pixar’s leverage is far greater than
240   the average company surveyed by RMA. On the upper quartile, the current ratio for RMA
      is 1.5, for Pixar, the lowest leverage in 2000 was about 7. Sales over assets is where Pixar
      appears to be lower than the RMA sample. This can be misleading because Pixar’s sales
      are large, but so are their assets and the larger assets will translate into a smaller number.
      Percentage pre-tax income over tangible net worth can also possibly be misleading
      because since Pixar’s assets are large, its net worth will be large and this figure will be
      smaller. Last total debts over total assets shows that Pixar has way lesser debts than the
      industry.

      Conclusion
250          By comparing the industry figures we can see that in many ways, Pixar exceeds
      the industry in assets, leverage, debt, and profitability.

      Appraisal of Fair Market Value
      Discounted Cash Flow Valuation
              The data is in Table V. This valuation will allow us to project future cash inflows
      to the company for 2003 to 2007. The year 2002 is taken as the base year instead of 2003
      because cash flow data is not available for 2003 yet. Since these amounts will be in the
      future, to satisfy the time value of money we take the present value of these numbers.

260            To actually calculate these future cash flows, historical data from 1997 to 2002
      was used to find a growth rate. Some erroneous data was removed to clean up the growth
      rate and the rate was also tapered by 10% each year so it does not grow to infinity. For
      sales, the growth rate was found to be 28.34% and this rate was applied to EBIT, income
      taxes, depreciation and change in working capital and required investment. Cost of good
      sold has its own growth rate because its historical data yielded a reasonable growth rate
      and its growth should be independent of sales.

             To find the cash flow to equity, we take net income added to depreciation and
      subtracted from change in working capital and required investment.
270
              We assume a terminal value of 0 for each year until the year 2007 when we find
      the terminal value if the company were to be liquidated. To find this we take the Earnings
      per share, (2007 projected net income divided by the number of shares ) multiplied by a
      Pixar Animation Studio Valuation                                                      Page 6 of 8
      P/E ratio of 9 which is considered appropriate for this case (see Mr. Richard Castanias).
      This value is taken and added to the last cash flow at 2007 to find the ending cash flows
      of the firm.

              Now to find the present values we first calculate the discount rate by
      multiplying the beta of the company by the market risk premium added to the risk free
280   rate. The risk free rate was obtained from US T-bond prices taken March 11, 2004. To
      get the present value, the PV formula in the spread sheet was used with the calculated
      discount rate. Finally, to find the net present value, we take the present values, then
      applied the spreadsheet formula for NPV at the same discount rate as the present value
      for the years 2003 to 2007. From the analysis it is estimated that the stock should have a
      value of $9.18.

             Just to summarize, here are the assumptions that we made:
             Sales (28.3%)
             COGS (12.4%)
290          Operating Expenses (28.3%)
             Depreciation (28.3%)
             Working Capital Investment (28.3%)
             Beta (0.56)    Discount Rate (9.32%)
             5 years projected out, 100% terminal value (I think)

      Findings using Discounted Cash Flows
              We have found that the growth rate for the company is positive and about 30%.
      Also we have found the Net present value to be about $507,960. We leave it for the next
      section (the conclusion) to discuss what this all means.
300
      Overall Conclusion
              To review, the purpose of this analysis is first to determine the fiscal health and
      soundness of Pixar Animation Studio. But more significantly, to see whether Pixar has
      the legs to stand on and thrive after Disney is no longer there to support them. This is of
      course referring to after the contractual agreement between Pixar and Disney expires.

              It looks probable that Pixar will part from Disney and looking at this valuation, it
      looks very likely that Pixar will continue to be a successful company. Most if not all
      indicators of financial strength show that Pixar is presently a very well performing
310   company. And now future expected earnings show that Pixar is expected to grow and
      gross a little over half a billion in present value future cash flows in the next 4-5 years.
      This cannot take for account the effect of a separation with Disney.

               Many of Pixar’s fiscal success have been almost certainly as a result of their
      affiliation with Disney. Therefore it could be expected that this split will be detrimental
      to Pixar. However, credit must be given to Pixar because of its innovation, leadership,
      and example in this bourgeoning industry. Also Disney with its influential leverage did
      set the terms of the contract fairly heavily in their favor for the part they take in these
      movies. The decision not to renew their partnership was probably seen as a way for Pixar

      Pixar Animation Studio Valuation                                                    Page 7 of 8
320   to renegotiate terms that are fairer for them. So that Pixar could have a larger piece of the
      pie that they themselves baked. In this sense, the split would be important to support this
      growth that is projected here in this report.

             Regardless, whether the belief is that the split will harm or hurt this company, the
      amount of future cash flows is large enough that sway in either direction would probably
      not come close to drastically altering the course that this company is heading. And this
      company is moving upwards. ◄


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      Pixar Animation Studio Valuation                                                    Page 8 of 8

								
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