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									AIM Student Research Report                                                                                Motion Pictures
This report is published for informational purposes
only by the students of the Association of Investment
Management (AIM), a student-run organization at the
Leonard N. Stern School of Business at New York
                                                                                 Pixar Animation Studio
November 19, ‘04                    Ticker: PIXR                                                           Recommendation: Buy
                                    Price: $86.60 (as of Nov. 19, „04)                                       Price Target: $99.56
Jessie Liu                Earnings/Share

Victor Fang                                            Mar.           Jun.           Sept.             Dec.        Year
                                    ‘01A               $0.15          $0.34          $0.23             $1.45       $2.17        39.9x
Dmitri Hu                           ‘02E                0.48           0.65           0.40              0.72        2.25        38.5x                ‘03E                 0.49          0.38            0.80             0.95        2.62         33.1x
                                    ‘04E                 0.42          0.51            0.90             1.03        2.85         30.4x
Alex Huang
                                      The Incredibles!
Arthur Hsu                           The Leader in CG-animated Film Industry: Pixar has established a dominant market position                  proved by outstanding past performance of its CG animated films. Of the nine CG animated films
                                      ranked among the top 100 films by box office, all Pixar‟s five films were in the list. Compared
                                      with its peers, Pixar has a unique creativity generating ability. With such capability, Pixar has
                                      successfully surpassed its competitors and created an unparalleled brand equity.
                                     The Industry Expected Higher Profit from New Revenue Sources: The hit-driven nature of
                                      film business might induce some doubts on the steadiness of Pixar‟s revenue. The growth of
                                      international box office and increasing home video revenue, however, will help Pixar stabilize its
                                      bottom line. Moreover, we are confident that CG animated films will be the main stream of the
                                      market in the future, providing prosperous outlook for the industry.
                                     Double Profits Around the Corner: After the delivery of Cars in „05, Disney/Pixar co-production
                                      agreement will come to an end. We believe that, with an established brand name and impeccable
                                      track records, Pixar will have a stronger bargaining power to seek a more favored contract with
                                      Disney or other potential partners, which will remarkably amplify Pixar‟s profitability and expand
                                      its production capacity.
                                     Recommend BUY with Target Price of $99.56: We believe the current price rally of Pixar has
                                      only factored in investors‟ healthy expectation for “the Incredibles”. Given the thriving industry
                                      outlook and Pixar‟s competitiveness, we believe it worth a higher P/E than it‟s currently traded.
                                      End of the co-production agreement with Disney may provide surprising earnings potential. We
                                      project a price target of $99.56 at 38.0 times of ‟05 EPS, with a potential upside of 15.0%. BUY.

             PIXR Daily Stock Price                                                             Market Profile
                                                                              52 Week Price Range                       60.60 - 93.42
                                                                              Average Daily Volume                           821090
  $85                                                                         Beta                                              0.563
  $80                                                                         Dividend Yield (Estimated)                       0.00%
                                                                              Shares Outstanding                             57.79M
  $75                                                                         Market Capitalization                            5.00B
                                                                              Institutional Holdings                            47%
  $65                                                                         Insider Holdings                                  71%
                                                                              Book Value per Share                           $19.45
   Nov-03    Feb-04    May-04   Aug-04
                                                                              Debt to Total Capital                              0%
                                                                              Return on Equity                                  17%

Association of Investment Management                                    Important disclosures appear at the back of this report
New York University Leonard N. Stern School of Business
Equity Research Report Competition
 Association of Investment Management                                                                                                  November 19, ‘04

                        Business Description: Leader in the CG-animated Film Industry
                        Pixar, as it describes itself in the vision statement, is a digital animation studio that combines creative and
                        technical artistry to create, develop and produce computer-animated feature films with heartwarming stories
                        and memorable characters that appeal to audiences of all ages. On top of films, Pixar‟s related products
                        include videos, toys, games and other merchandise. The revenue breakdown for one of Pixar‟s most notable
                        successes, “Finding Nemo,” is shown in Figure 1. Most revenues come from home video sales and box
                        office. In addition, the Company markets and sells its RenderMan software to other visual effects studios.

                        Figure 1: Finding Nemo Revenue Breakdown
                        Box office and home video account significantly for revenue.

                                                                                     Video game,
                                                                 M erchandise            4%
                                                                royalties, 15%
                                                                                                            Box office,
                                                          licensing, 11%

                                                                                  Home video,

                        Source: Pixar

                        Company Short History
                        In „86, Steve Jobs, CEO and one of the key founders of Pixar, purchased the computer division of Lucas Film
                        for $10 million in 1986 and founded Pixar Animation Studio. John Lasseter, executive vice president of
                        creativity of Pixar, was part of the Lucas Film deal and was also a key founder of Pixar. Mr. Jobs, who owns
                        an approximately 50% stake in Pixar, is also the current CEO of Apple Computer, Inc.

                        Ten years ago, animated films were still dominated by Disney‟s hand drawn animated movies. When “The
                        Lion King” made a tremendous success and broke records in the film history, no one knew that just five years
                        later, computer-generated (CG) animated feature films would replace hand drawn animated movies and
                        dominate the whole industry. It was Pixar that created this whole new generation of CG animation in the
                        film industry. Pixar‟s animated films surpassed many Hollywood traditional movies at the box office and
                        aroused a question from people, “Do we really need real actors and actresses for a great movie?” Pixar has
                        leveled up the film industry and defied typical economies.

                        Figure 2: Revenue and net income trend of Pixar vs. its released films
                        Trending up constantly.
                                        350    (US$m)                            Revenue           Net income







                                              '95       '96     '97        '98      '99     '00       '01       '02       '03   '04E    '05E

                        Source: Pixar

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                        Strong Performance of Pixar‟s Previous Films
                        As of November 15, „04, the Company has produced six full-length animated feature films: “Toy Story”
                        („95), “A Bug's Life” („98), “Toy Story 2” („99), “Monsters, Inc.” („01), “Finding Nemo” („03), and “the
                        Incredibles” („04). The films were marketed and distributed by The Walt Disney Company under the current
                        co-production agreement. These films, except for “the Incredibles”, grossed $2.6b box office and have sold
                        out approximately 160million home videos units.

                        “Toy Story”, the first 100% CG-animated feature film, was released on November 22, „95. The film received
                        tremendous critical acclaim and became the highest grossing film of „95, generating over $360m in
                        worldwide box office revenues. Since the success in “Toy Story”, Pixar has released “A Bug’s Life”, the
                        highest grossing animated film released in „98 and “Toy Story 2”, the highest domestic grossing animated
                        film released in „99. “Toy Story 2” broke numerous opening weekend records all over the world as well. In
                        „01, “Monsters, Inc.” reached over $100m at the domestic box office in just nine days, faster than any
                        animated film in history. Pixar has created a phenomenal record in the film history.

                        Pixar‟s fifth film “Finding Nemo” smashed box office records all over the world. “Finding Nemo” opened
                        domestically with an astounding $70.2m over the first three days and then followed with a $73.0m second
                        weekend showing at the box office, even more than first weekend box office. “Finding Nemo” is now the
                        highest grossing animated film worldwide in the film history and was awarded Best Oscar for Animated
                        Feature Film in „03. “The Incredibles”, Pixar‟s current release, featured with an opening weekend $70.4m at
                        the box office. The next Pixar film will be “Cars”, which is the last movie under the co-production
                        agreement with Disney.

                        Figure 3: CG Animated films ranked in the all time top 100 movies by box office
                        All Pixar featured films ranked among top 100 in the history.
                        Rank                                                   Title    Worldwide box office                 Producer
                        8                                           Finding Nemo                        865                       Pixar
                        10                                                  Shrek 2                    818.7              DreamWorks
                        31                                          Monsters, Inc.                     528.9                      Pixar
                        38                                              Toy Story 2                    485.7                      Pixar
                        46                                                    Shrek                    455.1              DreamWorks
                        70                                                  Ice Age                    378.3                       Fox
                        82                                                Toy Story                    358.1                      Pixar
                        84                                             A Bug's Life                    357.9                      Pixar
                        95                                                Dinosaur                     347.8                    Disney
                        Source: International Movie Database

                        The Brand Equity Has Been Established
                        We believe that Pixar has already successfully established its brand name in the CG animation film industry.
                        Pixar evolved from a good technology company to a great film studio, producing creative original stories
                        with quality guaranteed. Pixar‟s box office performance gradually attracted adults to their movies, which
                        were originally regarded as children-focused films.

                        Leading CG-animated Technology
                        About ten years ago, CG was only a small idea at Pixar. Nevertheless, Pixar has turned this small idea into a
                        respectful business and created a whole new generation in the animated films sector. Pixar has made many
                        important breakthroughs in the application of CG animation and maintained a monopoly in technology for
                        the CG-animated movie industry over the past seven to eight years. The company keeps attracting many
                        talented technological artists in this area. Pixar believes that its pioneering technology, which enables
                        animators to precisely control the motion of characters, combined with the great story line of each movie,
                        will distinguish its animated movies from all others. Pixar continues to invest heavily in these software
                        systems and believes that further advancements will lead to additional productivity and quality improvements
                        in making its CG animated films.

                        Distinguished Creativity Team
                        Mr. Lasseter, executive vice president of creativity, is leading a team of highly skilled animators, writers and
                        artists. Pixar instituted a special team called “Brain Trust”, which includes John Lasseter, six well-known

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 Association of Investment Management                                                                              November 19, ‘04

                        directors and dozens of staff. Storylines are presented to Pixar‟s “Brain Trust” which, in turn, gives candid
                        feedback to directors, ultimately creating for a better story. Pixar uses a collaborative and iterative process
                        and numerous checks to guarantee the quality and the creativity of the movies. In order to attract and retain
                        quality artists, the company founded Pixar University, which provides education for all of Pixar's employees.

                        Talented Management
                        Pixar‟s management structure is relied on key persons, especially Steve Jobs, Edwin E. Catmull, and John
                        Lasseter. Mr. Jobs has served as a director and the chief executive officer of Pixar since 1986 and also serves
                        as chief executive officer of Apple Computers, Inc. He is only responsible for negotiating new distribution
                        contracts and made important strategic decision of Pixar now. Mr. Catmull co-founded Pixar with Mr. Jobs.
                        Now, he serves as president and chief technical officer. He was the developer of RenderMan software and
                        won lots of prestigious awards for computer graphics and animation. John Lasseter, executive vice president
                        of creative, directed “Toy Story”, “A Bug‟s Life”, and “Toy Story 2”. He also executive produced the rest
                        three films released by Pixar and will be the director of “Cars”.

                        Outperforming the High Expectation
                        When looking at the pattern in the movement of Pixar‟s stock price, there appears to be something of an
                        “over-optimistic effect” before the release of each new film. Pixar‟s stock price appreciated on average
                        10.9% in the three months prior to the release of each new film but depreciated on average 8% in the year
                        after release date.

                        Figure 4: Price moves of previous five films before and after release dates
                        Outperforming high expectation in the recent two releases.
                                                                                               Price performance
                           Movie Title        Release date     Price           before release date            after release date
                                                                            1Y        6M        3M         3M         6M           1Y
                            Toy Story              „95/11/12   39.00       N/A        N/A       N/A      -40.0%     -42.0%      -59.0%
                           A Bug's life            „98/11/20   50.50     118.4%      23.0%     20.2%     -18.0%     -15.0%      -6.0%
                           Toy Story 2             „99/11/19   47.50      -5.7%      12.8%     27.1%     -24.0%     -22.0%      -39.0%
                         Monsters, Inc.            „01/11/2    36.70      11.4%      6.7%      -8.3%     -12.0%     13.0%       44.0%
                         Finding Nemo              „03/5/30    56.55      34.6%      -2.1%      4.7%      29.0%     24.0%       20.0%
                        Average price moves of
                                                                          39.7%      10.1%     10.9%     -13.0%      -8.4%      -8.0%
                        all previous productions
                        Average price moves of
                                                                          23.0%      2.3%      -1.8%      8.5%      18.5%       32.0%
                        the recent two productions
                        Source: Pixar, Bloomberg

                        Averaging over all of the five movies Pixar produced, we also observe a downward trend after the release
                        date. However, one note is that with Pixar‟s two most recent, “Monsters, Inc.” and “Finding Nemo”, the
                        stock price depreciated on average 1.8% in the three months prior to the release date and appreciated on
                        average 32% in the year after the release dates. Observing the price behavior with respect to the box office
                        revenues, we found out that Pixar‟s box office has exceeded investors‟ expectations for the latest two releases
                        and a huge rally of share price would follow, an interesting phenomenon investors should pay attention to.

                        “The Incredibles”
                        Pixar‟s latest film, “the Incredibles”, was released on November 5th, „04 with an opening weekend box
                        office $70.4m. This film's story revolves around the dysfunctional family problems that come up when
                        everyone works together as a super team called “the Incredibles”. “The Incredibles” are a family of
                        superheroes trying to live a normal, quiet life in the suburbs. After inadvertently uncovering an evil plan, the
                        family must bring their respective super skills to save the world.

                        We could observe some changes in “the Incredibles” from its previous five productions. First, the movie
                        length increases to about two hours, compared with one and a half hour in the past ones. Second, it is not a
                        traditional Pixar movie, which would probably make you laugh from the first minute to the last minute, and it
                        is Pixar‟s first PG-rated movie. While the movie is still a comedy, there are some serious tones We regard
                        these two major alterations as positive factors. Pixar could attract two kinds of potential consumers by doing

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 Association of Investment Management                                                                          November 19, ‘04

                        this. One kind of people don‟t like spend the same money seeing an one and a half hour long movie as a two
                        hour long movie and the other kind of people want to see a comedy with some insightful thoughts among it.
                        We believe the transition from a traditional comedy to a PG-rated comedy with insightful thoughts would
                        result in more diversified films of Pixar, which could increase box office further in the long term by
                        appealing to consumers other than comedy fans and families.

                        It‟s the least competitive releasing time schedule of Pixar‟s movies
                        DreamWorks postponed its “Shark Tale” up a month to October 1 and Warner Brothers also decided to move
                        its “Alexander” from November 5 to November 24. We doubt that it‟s because competitors try to avoid from
                        releasing their films in the same time schedule of “The Incredibles”. Pixar‟s 6 full-length movies were all
                        ranked 1st on the opening weekend. The opening weekend box offices of competitive movies released at the
                        same time schedule were all no more than 40 million dollars.

AIM Equity Research Report Competition                                                                                           5
 Association of Investment Management                                                                                  November 19, ‘04

                        Relationship with Disney
                        „91 - „97: Feature Film Agreement
                        In May 1991, Pixar struck a three-film agreement with Disney to distribute its movies. This agreement was
                        the companies‟ attempt to break into animated motion picture business. Pixar needed a partner who
                        understood the film market, had strong brand name and outstanding marketing capabilities. Disney was the
                        best candidate. In November „95, the first film released under this agreement was Toy Story that was a huge
                        success and beat everyone‟s expectations. Based on this success, Pixar approached Disney to turn their
                        relationship into a larger agreement.

                        „97 - „06: Co-Production Agreement
                        In February „97, Pixar and Disney entered into a new co-production agreement valid for five films made after
                        Toy Story. (see figure 5) The agreement was for Disney and Pixar to co-produce and co-own five original
                        films, co-finance the production costs of each film, and share equally the profits from each film and any
                        related merchandises or licensing revenues. A Bug‟s Life was the first movie that was included in this new
                        agreement. Toy Story 2, though its success, was not counted by Disney‟s CEO, Michael Eisner, toward the
                        five film deal since it was a sequel rather than an original idea. This was the beginning of the end for Pixar /
                        Disney Relationship.

                        The co-production agreement can be summarized as follows:

                        1.    Disney and Pixar share equally in the profits and the production costs of each film.

                        2.    Disney fronts the distribution fees and marketing costs associated with the domestic box office.

                        3.    Pixar earns revenue only after

                              a.     Disney recoups all of its marketing and distribution costs

                              b.     Disney receives a distribution fee, which ranges between 10-15%

                        4.    Disney has exclusive distribution and exploitation rights to the films, any derivative works (includes any
                              prequels, sequels, and spin-offs) and related ancillary products.

                        Figure 5: Five films under co-production agreement with Disney
                        Toy Story 2 did not count as one of the five films in the co-production agreement.
                                   Movie 1              Movie 2                   Movie 3                    Movie 4        Movie 5
                              „98              „99              „01                  „03                       „04            „05

                        Source: Pixar

                        „06: Finding a new deal
                        As Pixar delivers Cars in „05, the co-production agreement will come to an end. In February „04, Pixar and
                        Disney declared they were ending their discussion to renew this contract and Pixar will seek a new partner.
                        Pixar wanted to own 100% right of its films and continued to pay Disney a distribution fee similar to the

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 Association of Investment Management                                                                              November 19, ‘04

                        current one in return for 100% ownership of its past and future library, but Disney refused to sell its

                        Pixar, therefore, is aggressively talking with other distributors for a new deal. In our view, Pixar‟s ideal new
                        deal, which management often references, is the one that like George Lucas‟s existing deal with Twentieth
                        Century Fox for the Star War series. Figure 6 contrasts Pixar‟s existing deal with Disney versus George
                        Lucas‟s deal with Fox.

                        Figure 6: Detail of Disney/Pixar co-production agreement vs. Lucas/Fox production agreement
                        Pixar may seek a more favored deal after the end of co-production agreement.
                                                                                         Pixar/Disney                       Lucas/Fox
                        Distribution Fee                                                    10%-15%                                 7%
                                                                              Box office, home video
                        Eligible Revenue Streams                                                               Box office, home Video
                                                                                   TV, merchandise
                        Sequels                                              Disincentive for sequels          Sequel-focused strategy
                        Profit Split                                                             50/50          100% owned by Lucas
                        Source: Pixar

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 Association of Investment Management                                                                                November 19, ‘04

                        The Industry: Expected Higher Profit from New Sources
                        Computer-generated (CG) technology was introduced in early 80‟s to enhance the special effects of movies.
                        In „95, “Toy Story” of Pixar was the first animation movie which was finished by computer-generated
                        technology solely. Compared with traditional 2-D animation movie made by Disney and other producers,
                        CG animation films were extensively accepted by the public. Since then, DreamWorks, Disney and FOX
                        built their own CG animation team to set foot in this vigorous market. In past ten years, the average box
                        office of top 8 CG animation films ($531.0m) are much higher than that of top 8 non-CG animation films
                        ($391.1m). Pixar is the only companies which solely focused on the CG animation and also the formidable
                        market leader in this industry. The five films of Pixar are listed in top 100 films with highest international
                        box office.

                        Figure 7: CG Animated Films ranked in the all-time top 100 movies by box office
                        All Pixar featured films ranked among top 100 in the history.
                                               CG Animation                                         Non-CG animation
                        Film                                    Year Box Office Film                                   Year Box Office
                        Finding Nemo                              „03        865.0 Lion King                          1994         783.4
                        Shrek 2                                   „04        818.7 Tarzan                               „99        435.2
                        Monsters, Inc.                            „01        528.9 Dinosaur                             „00        347.8
                        Toy Story 2                               „99        485.7 Pocahontas                           „95        347.1
                                                                                   The Hunchback
                        Shrek                                     „01        455.1                                      „96        325.5
                                                                                   of Notre Dame
                        Ice Age                                   „02        378.3 101 Dalmatians                       „96        304.2
                        Toy Story                                 „95        358.1 Mulan                                „98        303.5
                        A Bug's Life,                             „98        357.9 Casper                               „95        282.3
                        Average                                              531.0 Average                                         391.1
                        Source: The Internet Movie Database

                        Hit-driven Business
                        Traditionally, producers in media industry are in a hit-driven business. The extraordinary success of one film
                        might affect the revenue of producer greatly. Most of big player in this industry tried hard to diversified “hit-
                        driven” risk by detailed planning of films every year. Most of them will have films with different styles and
                        target audiences to smooth the volatility of revenues. Compared with other major studios, such as Warner
                        Brothers, Universal and Fox, Pixar and DreamWorks are more sensitive to this risk. The annual productions
                        of these CG-focused companies are less than two films with similar expression but different storyline. The
                        stability of their revenues is highly uncertain. The success or failure of a single film will seriously affect the
                        revenue in a specific year.

                        Growing International Box Office
                        Before „00, the United States accounts for half of the worldwide box office sales. However, the ratio is
                        declining when the International Box Office Growing. The increase of international box office will increase
                        the revenue of these companies. CG animations are driving more expanding international revenue. For
                        example, “Finding Nemo” grossed $513.5 million internationally, which is 60.2% of worldwide box office;
                        whereas “Toy Story” grossed $166.48 million internationally, roughly 46.5% of worldwide box office.
                        Increase in international theatrical box office boosted the profit of animation film companies. Meanwhile,
                        international home video sale volumes also increase dramatically in recent years.

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 Association of Investment Management                                                                                       November 19, ‘04

                        Figure 8: International Box Office of CG Films
                        Increasingly important international market.

                                      55.0                                                                         52.8
                                                                          49.4                 50.1

                                             T oy Story       A Bug's   T oy Story    Shrek   Antz    Monsters,   Ice Age    Finding
                                                               Life         2                           Inc.                 Nemo
                        Source: The Internet Movie Database

                        The international box office has become one of the most important criterions of a film‟s success, which is
                        more remarkable for the movie with subject that is less arguable in other cultures. Most of the animated films
                        are lack of sensitive topics and focused on the entertainment of whole family. The CG animation films
                        gained their appeal for international viewers easily. Meanwhile, international box offices are increasing as
                        audiences outside US are more aware of the CG animation films and the brand of those companies.

                        Increasing Home Video Revenue
                        Traditionally, a studio‟s revenue is heavily relied on the box office, and the revenue from video tape and TV
                        channel is not a dominant portion of total income. However, with the prevalence of home theater systems,
                        such as DVD players and 5.1 surround sound system, more and more families would like to build their own
                        libraries of films. As the penetration rate of home theater systems soars, consumers will continue to buy
                        DVD as long as the story is attractive and the IMAGE is amazing. Compared with video tape, DVD is easier
                        to preserve and also owns higher quality of image. All these reasons induce the willingness of family to buy
                        DVDs rather to rent them. In addition, the unit price of DVD is higher than that of video tape, which
                        increases Pixar‟s profit margin. DVD is the cash cow business for studios which enjoy higher profit margin
                        on that. We believed that the revenue from home video will be higher in next years.

                        Figure 9: DVD and VHS penetration rate
                        DVD will be the main staple of the industry in the future..

                              100       (m units)                        DVD Player               DVD Recorder                VCR





                                         2000           2001            2002         2003     2004E     2005E       2006E        2007E
                        Source: IDC

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                        CG animation companies, a pure digital content provider, are rare studios that are directly benefits from the
                        development of digital content. Because CG animation files are produced in a purely digital format, the costs
                        to transform the films to DVD format are much lower, and the quality of DVDs is easier to maintain. At the
                        same time, CG animation companies will benefit when movie theaters equip with digital projectors and
                        equipment in next years. The format of digitized image makes it easier and cheaper to develop videogame
                        and sequels. In film industry, the sequels, most of time, can secure a certain box office, and lower the risk of
                        revenue. In addition, with more and more animation films in the library of “creativity producers”, the
                        production of sequels would increase the productivity of CG animation companies, and the revenue from
                        these films.

                        The Potential Threat of Piracy
                        For media industry, physical piracy was no novel news to the producers. Compared with video tape, DVD is
                        easier to copy and to maintain the image quality in the piracy copies. With more and more international
                        cooperation against the pirated editions, the loss from physical piracy is easing. Nevertheless, a whole-new
                        threat, on-line piracy, is looming on the horizon. Although the huge file size of films in DVD format
                        refrained the dissemination of digitization of contents, the higher downstream speed of broadband access at
                        home or in office will be a driving force of distribution of illegal copies on the Internet in near future. Until
                        now, there is no clear way to avoid ramping on-line piracy, the risk will be a major threat to the revenue of
                        animation companies in the coming years. In order to cope with piracy, more and more companies decide to
                        release movies worldwide simultaneously, which would decrease their loss from piracy. For example,
                        “Matrix Reloaded” was released in 65 countries at the same time, and more and more movies are released just
                        a few weeks after the domestic release.

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 Association of Investment Management                                                                               November 19, ‘04

                        Competitive Positioning: the Invincible Creativity Generator
                        Now, the major competitor is DreamWorks Animation Studios. Disney may become the major competitor in
                        the future if Pixar seek other distributor after the end of their co-production agreement. Other potential
                        competitors are Fox Animation Studios and Warner Brothers, each of them only has one CG-animated
                        production now.

                        Although more and more new entrants may intensify the competition, we still believe Pixar could survive and
                        even destroy some new entrants by its two unique advantages. One is “Pixar”, the brand name. As we
                        mentioned before, Pixar has been already a brand name, which is very important to keep attracting its loyal
                        old fans and new consumers of CG animation movies. People who consider to attempt new style moves, like
                        CG-animated movies, Pixar‟s movie is always their first priority because of the perfect box office record.
                        And the other is creativity. It‟s the core value of Pixar and we rarely see it in other competitor‟s movies.

                        Unparallel Creativity
                        All of the five films produced by Pixar have a perfect box office record. All of them are ranked among the
                        Top 100 movies by box office in the film history. Four of the top five animated films in recent years have
                        been CG-animated. Two of them were the last two Pixar films produced, “Finding Nemo” and “Monsters,
                        Inc.”, while three of the top five CG-animated films were released by Pixar.

                        Pixar was a monopoly in the CG-animation movie industry in its earlier stage. During that time, Pixar
                        dominated its competitors by its pioneering CG-animation technology. Not until “Shrek” was released, did
                        DreamWorks become the major competitor of Pixar. In „00, DreamWorks Animation bought out Pacific Data
                        Images, Inc. (PDI), which produced the CG- animation movie “Antz” in a joint venture with DreamWorks
                        Animation. Disney has been the leader in the 2D-animation movie industry and released its first CG-
                        animation movie-“Dinosaur” in May, „00. Disney may be a potential competitor in the future. It‟s interesting
                        that the box office of last three movies produced by Pixar grew at a faster rate than that of those productions
                        which was released before the increasing competition.

                        We believe that Pixar will successfully keep dominating in the CG-animation movie industry by its excellent
                        creativity. It continues to invent the original stories in its each production. We believe that creativity rather
                        than technology will dominate the CG-animation movie industry in the future when more and more studios
                        will be able to create complex visual images.

                        Although “Shrek” sequence is quite successful, we still think there must be some flaws in the creative process
                        of DreamWorks Animation. We could see that five of the nine animated films produced by DreamWorks
                        share similar story line or background with those produced by Pixar and Disney. (Four of the five were
                        released by Pixar) “Small Soldiers” is a story about toys that come to life, which is similar to “Toy Story”.
                        “Antz” is a story about an ant, who is an outcast among his own people. And this is also similar to “A Bug’s
                        Life”. “Road to EL Dorado” and “Emperor's New Groove”, which was produced by Disney, both are stories
                        about the ancient empire. “Shrek” and “Monsters, Inc.” are stories about a monster. And even “Shark Tale”
                        shares the same background with “Finding Nemo”, all talking about the underwater adventure of a fish.

AIM Equity Research Report Competition                                                                                                11
 Association of Investment Management                                                                                          November 19, ‘04

Figure 10: Comparison of Pixar‟s and DreamWorks‟ CG animation films
Coincidence? Or lack of creativity?
                                                               IMDB                                                                           IMDB
Title                     Release Date Box office                     Title                 Release Date      Producer     Box office
                                                              ratings                                                                        ratings
Small Soldiers                   Nov-97               64.3     5.8/10 Toy Story                   Nov-95          Pixar         358.2         7.9/10
Antz                              Oct-98            171.6      7.1/10 A Bug's life                Nov-98          Pixar           358         7.4/10
Prince of Egypt                   Dec-98            218.2
Road to EL                                                            Emperor's New
                                  Apr-00              76.4     6.3/10                             Dec-00         Disney         159.9         7.3/10
Dorado                                                                Groove
Shrek                            May-01             476.7      8.1/10 Monsters, Inc.              Nov-01          Pixar           529         8.0/10
Spirit                           May-02             122.5
Sinbad                            Jun-03              67.5
Shrek 2                          May-04             839.6
Shark Tale                        Sep-04             350*      5.8/10 Finding Nemo               May-03           Pixar         839.6         8.3/10
Average**                                           227.8     6.62/10 Average                                                  448.94        7.78/10
* Students estimates
** The average box-office of the gray-colored raw films.
Source: The Internet Movie Database

                                      We don‟t think DreamWorks intentionally mimic films produced by others because the release dates of some
                                      movies are quite closed. It may be just a coincidence. But even if it was just because of the coincidence, it
                                      still reveals that DreamWorks made poor story decisions and lacks of creativity compared to Pixar, whose
                                      story lines are all original stories that others haven‟t covered before. And in the every movie sharing the
                                      same story line with other movies, those of DreamWorks were underperformed compared to their
                                      counterparts. The average box office of those five films produced by DreamWorks is only half of that of the
                                      films with the same story line produced by Pixar and Disney. It implies even under the same story
                                      framework, the films released by Pixar still have greater quality than those released by DreamWorks.

                                      Disney has long history in making animated films and dominated the 2D-animation film industry. Disney
                                      will start to produce its own CG animation films after the termination of the co-production agreement with
                                      Pixar. However, we don‟t know if Disney will become a formidable competitor of Pixar given that most of
                                      its animated films are old stories. Up to now, we think it is fair to say that Disney does not demonstrate a
                                      great ability in creativity generating. But it is worthwhile to pay close attention to the future development.

AIM Equity Research Report Competition                                                                                                           12
 Association of Investment Management                                                                                 November 19, ‘04

                        Earnings Analysis
                        It seems that Pixar is a company easy to evaluate in that it spends money to produce animation films and
                        collects revenue from box office sales. Pixar, however, has multiple revenue streams including home video,
                        TV/Broadcasting, Merchandise Royalties and Game Sales. Moreover, each revenue source has its own
                        distribution fees, revenue share and recognition timeline. (See figure 11) For example, revenue of third
                        quarter „04 included revenues of Monsters Inc., Finding Nemo and library from Toy Story, A Bug’s Life and
                        Toy Story 2.

                        Figure 11: Estimated revenue recognition timeline
                        Number of Months:                   0-3        3-6      6-9     9-11     11-24       24-35    35-48    48-60
                        Domestic theatrical
                        International theatrical
                        Domestic home video
                        International home video
                        TV broadcasting
                        Video games
                        Source: Student estimate

                        Model Overview
                        In our product model, we begin by predicting a given movie‟s revenues and profits and then we layer in the
                        revenue source and duration.

                        1. Revenue Recognition
                        It is noteworthy that Pixar‟s revenues are reported net of all movie-related expenses. That is, Pixar‟s top line
                        is net of revenue share with the theaters, distribution expenses and marketing costs etc.(See figure 12
                        below) .Pixar‟s revenue can be categorized into six parts:

                        Figure 12: Illustration of Profit Sharing between Pixar and Disney (Toy Story 2)


                            World Wide
                            Box Office
                             $486m                                                                                             Pixar
                                                                     Less: 12.5%                Less:                         $88.5m
                                            50%                      distribution             35million
                                                                        fee for               marketing
                                                           Pixar       Disney       Remaining   cost      Remaining
                                                          $243m                      $212m                 $177m


                        Source: Pixar, student estimate

                        Box Office Revenues: It is extremely difficult to evaluate a movie‟s box office. However, given Pixar‟s
                        record, we attempt to make reasonable estimates of “The Incredibles” based on average past opening
                        weekend box office. In terms of international box office, we conservatively estimate it will be 20% higher
                        than domestic revenues. We believe it is a conservative estimate given that the ratio of Finding Nemo is 55%
                        and the recent trends of international appeal keeps growing.

AIM Equity Research Report Competition                                                                                                 13
 Association of Investment Management                                                                               November 19, ‘04

                        Figure 13: Ratio of International/US Box Office
                        The trend is picking up.
                        Film                                  Toy Story   Bug's Life      Toy Story 2     Monsters Inc.    Finding Nemo
                        U.S box office                          191.80      162.80            245.90           255.90             339.70
                        International box office                166.40      195.20            239.90           273.10             524.90
                        WW box office                           358.20      358.00            485.80           529.00             864.60
                        International/U.S                          87%        120%              98%             107%               155%
                        Source: The Internet Movie Database

                        Box Office Expenses: A Pixar movie currently costs between $100m and $200m that include distribution
                        fees and marketing costs. Currently, Pixar splits production and marketing costs with Disney 50/50. Disney
                        fronts all print and advertising costs, resulting in a net payment to Pixar.

                        Home Video Revenues: Video sales are driven by the number of units and average selling prices. We
                        estimate Pixar will sell 51 million units for “the Incredibles”. This is about 2% higher than our estimate for
                        Finding Nemo unit sales. In addition, world DVD penetration will continue to climb. Thus, we forecast an
                        increase in average wholesale selling price as DVD price is higher than VCD or VHS.

                        Licensing of TV/Broadcasting: Revenue from licensing of TV/Broadcasting typically range between 15-
                        20% of worldwide box office. We estimate Pixar will generate 18% TV/Broadcasting revenues (as a percent
                        of worldwide box office) going forward less a distribution fee.

                        Merchandise Revenues: We estimate Pixar generates about $800-1500 million of merchandising revenue
                        for each of its movies and collects an estimated 10% licensing fee for the use of its movie. The company also
                        must pay a distribution fee for this revenue source.

                        Game Sale Revenues: Video Game sales only represent a small portion of Pixar‟s revenue. We estimate the
                        game for “the Incredibles” will sell 600million units and generate $17.5 million for Pixar.

                        Software Revenues: Pixar has been licensing its RenderMan software for 16 years ,which enables other
                        studios to create visual effects. This revenue stream is unpredictable, but it is extremely high margin, carrying
                        virtually zero costs. In „04, we estimate this revenue stream will contribute $12.6 million to the top line.

                        2. Film Production Costs
                        Pixar splits film production costs 50/50 with Disney (under the current co-production agreement), and it
                        capitalizes its share of production costs, which primarily includes salaries, equipment, and overhead. When a
                        film is released, Pixar amortizes the film‟s capitalized costs proportionate to the revenue that is anticipated
                        from all sources under the individual-film-forecast-computation method. In other words, the amount of
                        quarterly film amortization is based on Pixar‟s assessment of how much it believes the movie will collect at
                        the box office (and other revenue streams). Gross receipt forecasts change during a movie release, so Pixar
                        must adjust the percentage of amortization in each period prior to reporting. In our model, we forecast
                        capitalized film production costs to be relatively stable. For more details, please refer to our financial models
                        in figure 19.

                        Potential Benefits of New Contract
                        Some may concern about the termination of Pixar/ Disney agreement, arguing that it will negatively impact
                        Pixar‟s operation. In our view, however, given its stellar box office records, Pixar has established a strong
                        brand name and now have a larger bargain power to seek another partner and a more favorable contract. In
                        other words, we view it as a great opportunity for Pixar to advance to another rapid growth rather than a
                        negative impact.

                        1. Retaining Larger Portion of a Film‟s Profit:
                        Figure 14 further illustrate the differences between Pixar‟s revenue and profit of Monsters, Inc. under
                        Disney/Pixar agreement and Lucas-type agreement.

AIM Equity Research Report Competition                                                                                                14
 Association of Investment Management                                                                              November 19, ‘04

                        Figure 14: Scenario analysis: profit sharing under different production agreement for Finding Nemo
                        Surprising earnings potential in the future.
                                                                              Under Current        Pixar Under Lucas-Type Agreement
                                                                       Production Agreement                     (7% Distribution Fee)
                        Box Office Revenue                       865                    158                                      402
                        Box Office Profit                        214                      39                                          99

                        Home Video Revenue                       841                    177                                          782
                        Home Video Profit                        439                      92                                         408

                        Television Revenue                       120                      53                                         112
                        Television Profit                        108                      47                                         100

                                                                 170                      74                                         158
                        Royalty Revenue
                                                                 144                      63                                         134
                        Royalty Profit

                        Total Revenue                           1995                    461                                        1454
                        Total Profit                             905                    242                                          742
                        % of total Film's Profit               100%                     27%                                         82%
                        Source: Student estimate

                        Under existing agreement, Pixar only gets 18.22% of box office profit, after sharing profit with theaters and
                        Disney. However, the profit ratio will surge to 46.26% if Pixar adopted Lucas-style agreement. In other
                        segments, such as Home Video and Merchandise, Pixar would enjoy major portion of profit after new
                        agreement. In summary, the allotted profit ratio of a film for Pixar would increase from 27% to 82% by
                        forthcoming new agreement.

                        2. Expanding film production capacity
                        In CG animation film industry, all of the characters in films saved in digital format can be reused in the
                        sequel. By leveraging these materials, the lead time for sequels will be shorten and the cost of sequels will be
                        lower than that of a film with new characters. However, under the existing agreement with Disney, Pixar
                        lacks the initiative to produce sequel. For example, “Toy Story 2” was not counted in the five films under
                        agreement. In order to fulfill the contract with Disney, Pixar will put more resources on totally new stories.
                        If Pixar can get a new agreement like that of Lucas, it would increase its possibility to make more sequels and
                        enhance its efficiency of using resources. The potential high gross profit margin and more productions per
                        year will boost the profit of Pixar in future.

AIM Equity Research Report Competition                                                                                               15
 Association of Investment Management                                                                              November 19, ‘04

                        Investment Risks
                        The Risk of Stained Box Office Record
                        Pixar is a one-product company, which only focuses on CG animation and lacks diversification. Pixar‟s
                        perfect five-for-five batting rate has driven a valuation premium. Lots of analyzer doubted the sustainability
                        of Pixar‟s perfect record though the comment has been made for years and has not materialized until now. At
                        some point, however, investors‟ high expectations might not be reached by a not-that-successful film, and the
                        stained records will induce a psychological impact that might haul down its stock price.

                        The Uncertainty Partnership with Disney
                        The co-production agreement will be ended in „05 after Pixar delivering “Cars”, which will change Pixar‟s
                        risk profile. If Pixar decide not to renew the agreement with Disney, it will enjoy 100% profit except for
                        distribution fee, but also assume 100% of the costs related to producing and marketing its films. It will loss
                        the priority to get a better release schedule from Disney and will be forced to find other powerful partners for
                        its merchandise and home video. Moreover, on the basis of existing agreement, Disney can produce any
                        sequels of Pixar‟s current library without its consent. Disney‟s edition of sequel, such as Toy Story 3, might
                        blemish Pixar‟s reputation, which will be uncontrollable by Pixar. However, the potential of Eisner‟s early
                        leave might increase the likelihood of reconciliation between them.

                        Key Person Risk
                        Pixar‟s key persons are extremely complementary. Steve Jobs, Chairman and Chief Executive Officer, is
                        responsible for strategic development. Dr. Ed Catmull, president and co-founder, brought his high-
                        technology expertise to the film industry. As a chief technical officer, he contributes and nurtures key
                        technology in Pixar. John A. Lasseter, executive vice president of creative, is a two-time Academy Award-
                        winning director. When CG technology commoditizing, he will play a more important role to assure the
                        success of future hits. In March „01, Mr. Lasseter signed a ten-year contract with the company. In our view,
                        the delicate equilibrium between these three key persons might be spoiled by the loss of any one of them, and
                        affect the long-term success of Pixar.

                        Competition May Become More Fiercely
                        With the wide acceptance of CG animations, more and more companies have established their own team for
                        CG films. The recent success of Shrek 2 has proven DreamWorks to be a respectable competitor, especially
                        after it announced to focus more on CG animation. With the popularization of CG technology, Pixar‟s
                        competitive advantage on technology was not that outstanding. Disney still own great storyteller for play
                        script which will be the key factor in the industry in future. Meanwhile, other major studios are potential
                        competitors in this field.

AIM Equity Research Report Competition                                                                                               16
 Association of Investment Management                                                                           November 19, ‘04

                        Valuation: Recommend BUY with target of $99.56
                        Our valuation for Pixar is based on both valuation multiples as well as discounted cashflow (DCF) method.
                        We believe Pixar‟s share price has recently been factoring in the expected strong performance of “the
                        Incredibles”. The stock is trading at its relative peak P/E range at 33x of our ‟05 estimated EPS; however,
                        we believe current valuation multiples reflect only prospects of “the Incredibles”. We urge investors to pay
                        more attention to Pixar‟s value and creativity generating ability when projecting a reasonable future P/E
                        multiple. Further, our DCF-based valuation also supports our argument that we can expect Pixar to challenge
                        a higher P/E multiple in the next generation of its operation.

                        Comparable P/E multiple valuation: target price $99.56
                        We find there is rarely a truly comparable company to Pixar other than DreamWorks. However, given the
                        short trading history of DreamWorks, we don‟t think the P/E history of DreamWorks provide much relevant
                        information to gauge Pixar‟s fair P/E multiple range. In order to value Pixar using comparable P/E multiple,
                        we will more focus on its organic growth.

                        Since its listing on NASDAQ, Pixar has constantly demonstrated its ability to generate decent return for
                        shareholders. From figure 15, we can find that since its initial public offering on NASDAQ on November 29,
                        „95, Pixar has generated a 239.3% return for shareholders over almost nine-year period, or 26.6% return per
                        annum. During the nine years, shareholders have experienced the rapid expansion in TMT sector, the burst
                        of dot-com bubble, and the turmoil in stock market after 911 terrorist attack, etc. However, Pixar‟s
                        shareholders have benefit from the management‟s profit generating ability. We believe the management of
                        Pixar will maintain its ability to generate value for investors in the long term.

                        Figure 15: Market value of Pixar
                        Constantly generating shareholder value throughout its inception

                                  6,000      (US$m)

                                  5,000                                                                           5,067




                                       Nov-95              Nov-97              Nov-99      Nov-01            Nov-03
                        Source: Bloomberg

                        Some people may argue that Pixar has already reached its peak P/E after investors have factored in the strong
                        momentum of “the Incredibles” after its first two weeks box office. However, we believe that Pixar is more a
                        creative “story teller” rather than just a pure animation manufacturer as it was. As we mentioned, comparing
                        to Disney and DreamWorks, Pixar has a superior ability to generate creativity. We believe Pixar should
                        worth a much higher P/E multiple than its peers.

                        Further, as we discussed about Pixar‟s relationship with Disney, we used the most conservative scenario in
                        our earnings estimate. We still choose to err on the conservative side. However, we want to remind
                        investors that, after the contractual relationship with Disney terminated in ‟06, we believe investors can
                        expect further upside, which we believe justifies higher expected P/E multiple.

                        From the P/E band chart below, we can see that during the company‟s early years, it was even trading at an
                        extremely high P/E multiple at triple-digit number. However, investors are no longer raged about the rosy
                        stories of dot-coms. We believe it provides more relevance to look at its “post-TMT bubble” P/E trading

AIM Equity Research Report Competition                                                                                            17
 Association of Investment Management                                                                                           November 19, ‘04

                                       range. We believe the P/E multiple after „00 will provide more information about the fair valuation multiple
                                       for Pixar.

Figure 16: Historical and “post-TMT bubble” one year forward P/E Bands
We project a higher P/E multiple than historical average in the long-term future.

     400          (times)                                                           60.0   (times)

     300                                                                                                                                 +1.96 Std
                                                                                                                                         +1.00 Std

     200                                                                            30.0                                                    M ean

                                                                                                                                         -1.00 Std
     100                                                                                                                                 -1.96 Std

         -                                                                             -
         Dec-95        Dec-97           Dec-99      Dec-01     Dec-03                  Jan-00   Jan-01    Jan-02     Jan-03     Jan-04

Source: Bloomberg, Student Estimates

                                       After ‟00, Pixar has been trading at a mean P/E multiple of 30.0x. The previous peak P/E multiple, we
                                       believe, was due to investors‟ expectation for the release of “Monsters, Inc”. After “Monsters, Inc.”, the
                                       lowest P/E trading range of Pixar was around 23x. The success of “Finding Nemo” has helped Pixar to
                                       regain its favor by investors. On top of the expected success of “the Incredibles”, our projected bottom line
                                       growth rate at 16% and 12% for Pixar in ‟05 and ‟06 respectively also convince us can at least maintain to
                                       trade at current P/E of 33.0x. However, we are confident that, given Pixar‟s healthy business outlook in the
                                       near-term future, Pixar should worth a higher value.

                                       To sum up, given the foreseeable healthy momentum in the CG industry in the next decade, Pixar‟s leading
                                       position among peers, and potential upside from its business strategy to deal with competition and its
                                       relationship with Disney, we forecast that its „05 and ‟06 EPS to be $2.62 and $2.92 respectively. We
                                       therefore recommend BUY on Pixar with a target price of $99.56 at ‟05 EPS of 38.0 times, with a potential
                                       upside of 15.0%.

                                       DCF valuation at $99.47 supports our comparable multiple valuation
                                       For investors who prefer other valuation measures, we also looked at the most fundamental valuation
                                       method – discounted cashflow valuation. We have conducted a two-stage DCF analysis to gauge the
                                       assumption under which the company‟s DCF-based value at $99.47 per share. Again, we would like to
                                       remind investors of the future catalysts for more stock prices upside – CG industry momentum and Pixar‟s
                                       strategy positioning.

                                       Our valuation is based on a cost of equity of 8.6% and a weighted average cost of capital 8.2%. We want to
                                       remind investors that we have not incorporated the impact of exercise of bonus share option, and thus the
                                       possible dilution of earnings. However, we are confident in Pixar‟s ability to generate value for shareholders
                                       given its proven track record for the past decade. Further, we believe Pixar is on its way transforming itself
                                       from an animation manufacturer to a “creativity factory”. Hence, it is worthwhile to look at the FCF stream a
                                       bit further out into its promising future.

AIM Equity Research Report Competition                                                                                                               18
 Association of Investment Management                                                                                           November 19, ‘04

Figure 17: DCF valuation
DCF valuation derived equity fair value at $99.47 supports our 38.0x „05E EPS target of $99.56
                                Unit           „04E          „05E     „06E     „07E     „08E      „09E     „10E     „11E     „12E     „13E     „14E
EBITDA                        US'000          195.9         236.9    263.4    271.5    219.0     163.2    204.5    255.4    317.9    394.4    487.9
Change in working capital US'000                 2.2         (8.3)    (0.0)     0.7      6.9      (0.4)    (0.7)    (1.1)    (1.5)    (1.9)    (2.4)
Taxes on EBIT                 US'000         (70.6)         (68.7)   (83.5)   (93.2)   (96.1)    (77.0)   (56.7)   (71.7)   (90.2) (113.0) (140.9)
CAPEX                         US'000        (107.8)         (53.2)   (53.2)   (53.2)   (53.2)    (53.2)   (53.2)   (53.2)   (53.2)   (53.2)   (53.2)
Unleveraged FCF               US'000            19.7        106.7    126.8    125.9     76.7      32.6     93.9    129.5    173.0    226.3    291.4

Terminal value                US'000        8,376.8

Discount period
NPV - FCF                     US'000          879.7          99.1    109.4    101.0     57.1      22.6     60.4     77.4     96.1    116.8    139.7
NPV - TV                      US'000        4,016.0

DCF derived firm value        US'000        4,895.7
Net cash (debt)               US'000          928.8

Equity fair value             US'000        5,824.4
  per share                       $           99.48
                                Source: Student estimates

AIM Equity Research Report Competition                                                                                                           19
 Association of Investment Management                                                                            November 19, ‘04

                        Investment Summary
                        Pixar has established a dominant market position proved by outstanding past performance of its CG animated
                        films. Of the nine CG animated films ranked among the top 100 films by box office, all Pixar‟s five films
                        were in the list. We believe given the company‟s proven track record and its differentiating strength in
                        creativity generation, the momentum of the company shall continue toward the future. The unique creativity
                        generating ability of Pixar will set it apart from its competitors. In an industry where creativity is the key
                        production asset of players, Pixar has successfully surpassed its competitors and created an unparalleled
                        brand equity.

                        Traditionally, film producers‟ earnings were highly driven by the success of films. Such hit-driven nature of
                        film business might cast some doubts on the stability of Pixar‟s profitability. Moreover, such nature might
                        increase the volatility of film producers‟ share price performance. However, we have observed that the
                        international box office of films released recently have been increasing from approximately 40% to 60%
                        within a decade. Secondly, the increasing penetration of DVD/VCD into households, we believe, will help
                        Pixar stabilize its operating performance. Thirdly, CG animated films has replaced the traditional 2-D
                        animations in the past decade, and we are confident that the trend will continue into future, and CG animated
                        films be the main staple of the market in the future. All these factors provide positive outlook for the

                        We believe investors can expect a surprising earning upside after the delivery of Cars in „05, when
                        Disney/Pixar co-production agreement will come to an end. Given the established brand name and
                        impeccable track records, as well as the healthy industry environment, Pixar will have a stronger bargaining
                        power to seek a more favored contract with Disney or other potential partners. We believe at that time Pixar
                        will be able to remarkably amplify its profitability and expand its production capacity. We believe this is an
                        upside for us to raise our earning estimates. However, we factored a more conservative scenario in our
                        earnings forecasts, but we also remind investors of the potential upside.

                        On the downside, we also want to remind investors Pixar is a one-product company, which only focuses on
                        CG animation and lacks diversification. The co-production agreement will be ended in „05 after Pixar
                        delivering “Cars”, which will change Pixar‟s risk profile. If Pixar decide not to renew the agreement with
                        Disney, it will enjoy 100% profit except for distribution fee, but also assume 100% of the costs related to
                        producing and marketing its films. This is also a reason why we chose to be conservative when we did our
                        earnings analysis. The key-person focused strategy is also noteworthy mentioning. Further, with the wide
                        acceptance of CG animations, competitions may be fiercer. All these factors are worthy of investors‟
                        attention as well.

                        Given our analysis, we believe the current price rally of Pixar has only factored in investors‟ healthy
                        expectation for “the Incredibles”. Given the thriving industry outlook and Pixar‟s competitive industry
                        positioning, we believe it worth a higher P/E than it‟s currently traded. The termination of the co-production
                        agreement with Disney may provide surprising earnings potential. We project a price target of $99.56 at 38.0
                        times of ‟05 EPS, with a potential upside of 15.0%. Moreover, our DCF valuation also derived a fair equity
                        value per share of $99.47, which also supports our comparable P/E multiple valuation. BUY.

AIM Equity Research Report Competition                                                                                             20
 Association of Investment Management                                                                                     November 19, ‘04

Figure 19: Sales model
$ in thousand, %

                                                            Toy Story   Monsters     Finding        The
Film                               Toy Story   Bug's Life                                                    The Cars     Film8      Film9
                                                                2        Inc.         Nemo       Incredibles

Release Date                       11/22/95    11/20/98     11/24/99    11/4/01      5/7/03       11/5/04     11/4/05E
Box Office
Domestic Box Office                  191,733      162,793     245,852     255,830     339,715       341,935     360,000    360,000   360,000
International Multiplier                87%         120%         98%        107%        155%          120%        125%       125%      125%
International Box Office             166,342      195,192     239,853     273,025     524,923       410,321     450,000    450,000   450,000
Total Box Office Revenue             358,075      357,985     485,705     528,855     864,638       752,256     810,000    810,000   810,000
Studio Share                            50%          50%         50%         50%         50%           50%         50%        50%       50%
Studio Theatrical Revenues           179,037      178,992     242,853     264,428     432,319       376,128     405,000    405,000   405,000
Less: Distribution Fee                23,967       20,349      30,732      31,979      42,464        42,742      45,000     45,000    45,000
Less: Marketing Costs                 25,960       25,954      35,214      38,342      62,686        54,539      58,725     58,725    58,725
Net Theatrical Revenues              129,110      132,689     176,907     194,107     327,168       278,848     301,275    301,275   301,275
Net Theatrical Revenues               16,139       66,345      88,454      97,053     163,584       139,424     150,638    150,638   150,638
% of revenue                            15%          31%         27%         30%         34%           28%         28%        28%       28%

Home Video
Units Sold(mm)                            45           25          35          35          50            53          57         57        57
Assumed DVD & VCD Split                 30%          35%         40%         58%         76%           83%         83%        83%       83%
Assumed DVD & VCD ASP                  17.00        17.20       17.45       17.65       17.90         18.30       18.30      18.30     18.30
Assumed VHS Split                       70%          65%         60%         42%         24%           17%         17%        17%       17%
Assumed VHS Average Price               13.4         13.4        13.4        13.4        13.4          13.4        13.4       13.4      13.4
Total Home Video Revenues            651,600      368,250     525,700     555,275     841,000       919,776     990,379    990,379   990,379
Home Video Costs                     280,188      158,348     226,051     238,768     361,630       395,504     425,863    425,863   425,863
Less: Distribution Fee                97,740       55,238      78,855      83,291     126,150       137,966     148,557    148,557   148,557
Net Home Video Revenues              273,672      154,665     220,794     233,216     353,220       386,306     415,959    415,959   415,959
Net Home Video Revenues--Pixar        34,209       77,333     110,397     116,608     176,610       193,153     207,980    207,980   207,980
% of revenue                            33%          37%         34%         36%         36%           39%         39%        39%       39%

Gross Revenues                        76,709       65,117      98,341     102,332     120,000       135,406     145,800    145,800   145,800
Less: Distribution Fee                 9,589        8,140      12,293      12,792      15,000        16,926      18,225     18,225    18,225
Net Revenues                          67,120       56,977      86,048      89,541     105,000       118,480     127,575    127,575   127,575
Net - Pixar                           33,560       28,489      43,024      44,770      52,500        59,240      63,788     63,788    63,788
% of revenue                            32%          13%         13%         14%         11%           12%         12%        12%       12%

Merchandise Royalties
Net Merchandise Revenues              47,887       81,397     170,926     127,915     169,858       203,109     218,700    218,700   218,700
Less: Distribution Fee                 5,986       10,175      21,366      15,989      21,232        25,389      27,338     27,338    27,338
Net Merchandise Revenues              41,901       71,222     149,560     111,926     148,626       177,720     191,363    191,363   191,363
Net Merchandise Revenues--Pixar       20,951       35,611      74,780      55,963      74,313        88,860      95,681     95,681    95,681
% of revenue                            20%          17%         23%         17%         15%           18%         18%        18%       18%

Video Game Sales
Units Sold(MM)                            0             2           3          4.5         6.5            6           6          6         6
License fee per unit                      0             4           4            4           6            6           6          6         6
Net Video Game Revenue                     -        8,000      12,000      18,000      39,000        36,108      38,880     38,880    38,880
Net Video Game Revenue--Pixar              -        4,000       6,000       9,000      19,500        18,054      19,440     19,440    19,440
% of revenue                             0%           2%          2%          3%          4%            4%          4%         4%        4%

Total Revenues                       104,859      211,777      22,655     323,394     486,507       498,731     537,526    537,526   537,526
Source: Pixar, Student Estimates

AIM Equity Research Report Competition                                                                                                   21
 Association of Investment Management                                                                                           November 19, ‘04

Figure 20: Income Statement
$ in thousand

                                    ‘03A     1Q04A    2Q04A    3Q04A    4Q04E    1Q05E    2Q05E    3Q05E    4Q05E    1Q06E    2Q06E    3Q06E    4Q06E

Revenue                            262,498   53,824   66,289   44,463   98,118   57,370   45,263   92,388 109,717    53,280   59,961 104,908 119,707
Cost of revenue                     38,058    5,900    6,455    4,204   13,872    6,118    6,373    6,619    6,857    7,086    7,307    7,521    7,727
Gross Profit                       224,440   47,924   59,834   40,259   84,246   51,251   38,889   85,768 102,860    46,194   52,654   97,387 111,981

Operating expenses
   Selling and marketing             2,422     372      635      737     2,944     717      566     1,155    1,371     883      994     1,739    1,984
   General and administrative       12,783    2,846    3,060    3,658    6,832    4,221    3,736    5,621    6,315    4,110    4,384    6,227    6,834
   Research and Development         15,311    3,396    4,176    4,224   10,793    4,876    3,847    7,853    9,326    5,062    5,696    9,966   11,372
   Total operating expenses         30,516    6,614    7,871    8,619   20,568    9,814    8,149   14,629   17,012   10,055   11,075   17,932   20,190

Operating income                   193,924   41,310   51,962   31,640   63,678   41,437   30,740   71,139   85,848   36,139   41,580   79,455   91,790

   Other income, net                10,517    2,896    3,181    5,210    5,405    5,583    5,597    5,580    5,055    4,261    6,920    6,906    6,638
Income before taxes                204,441   44,206   55,143   36,851   69,083   47,020   36,336   76,719   90,903   40,400   48,499   86,361   98,428

   Income taxes expenses            79,673   17,228   17,370   13,266   26,922   18,324   14,161   29,898   35,426   15,744   18,901   33,656   38,359

Net income                         124,768   26,978   37,773   23,584   42,160   28,696   22,176   46,821   55,477   24,656   29,599   52,705   60,070

EPS - dilutive                        2.17     0.48     0.65     0.40     0.72     0.49     0.38     0.80     0.95     0.42     0.51     0.90     1.03
Source: Pixar, Student Estimates

AIM Equity Research Report Competition                                                                                                            22
 Association of Investment Management                                                                       November 19, ‘04

Figure 21: Balance Sheet
$ in thousand

                                                 ‘02A            ‘03A            ‘04E            ‘05E              ‘06E
    Cash and cash equivalent                            44,431          48,320      120,407              6,113            16,070
    Investments                                     294,652         473,603         808,373         708,373           947,505
    Accounts receivable                                  7,572           6,617           8,882           9,932            10,836
    Receivables from Disney                         129,339         197,177             21,505      360,713           262,372
    Other current assets                                13,826           1,047           1,047           1,047             1,047
    Current assets                                  489,820         726,764         960,214       1,086,178         1,237,830

    Plant, property, and equipments (net)           118,193         115,796         121,736         114,032           106,329
    Capitalized production costs                        91,334      106,897         171,478         199,131           223,112
    Other assets                                        32,719          51,496          51,496          51,496            51,496
    Total assets                                    732,066       1,000,953       1,304,924       1,450,837         1,618,766

Liability and shareholders' equity
    Accounts payable and unearned revenue                9,682           9,841          14,348           7,092             7,992
    Short-term borrowing                                    0               0               0               0                 0
    Other current liabilities                            9,322          50,602          50,602          50,602            50,602
    Current liabilities                                 19,004          60,443          64,950          57,694            58,594

    Long-term borrowing                                     0               0               0               0                 0
    Other liabilities                                       0               0               0               0                 0
    Total liabilities                                   19,004          60,443          64,950          57,694            58,594

    Contributed capital                             442,477         546,999         715,967         715,967           715,967
    Retained earnings                               268,429         393,197         523,693         676,862           843,891
    Other shareholders' equity                           2,156            314             314             314               314
    Total shareholders' equity                      713,062         940,510       1,239,974       1,393,143         1,560,172

    Total liabilities and shareholders' equity      732,066       1,000,953       1,304,924       1,450,837         1,618,766
Source: Pixar, Student Estimates

AIM Equity Research Report Competition                                                                                       23
 Association of Investment Management                                                                       November 19, ‘04

Figure 22: Statement of Cash Flows
$ in thousand

                                                       ‘02A           ‘03A           ‘04E           ‘05E           ‘06E
Net income                                                89,950        124,768        130,496        153,169        167,029
    Depreciation                                              7,661          7,760          7,322          7,703          7,703
    Capitalized film production costs                    (43,915)       (53,155)       (94,546)       (53,155)       (53,155)
    Amortization of film production costs                 39,420         37,592         29,965         25,502         29,175
    Loss (gain) on sale of PP&E                                 (8)             0              0              0              0
    Loss (gain) on sale of investments                        (439)      (1,259)        (1,739)               0              0
    Tax benefit from stock option exercises               38,592         39,358         63,259                0              0

    Decrease (increase) in accounts receivable                (424)           955       (2,265)        (1,050)            (904)
    Decrease (increase) in receivables from Disney      (115,827)       (67,838)       175,672       (339,208)        98,341
    Decrease (increase) in other current assets          (10,298)        12,779                0              0              0
    Decrease (increase) in other assets                  (11,046)       (18,777)               0              0              0
    Increase (decrease) in accounts payable                   2,726           159           4,507      (7,256)             900
    Increase (decrease) in other current liabilities      (1,330)        41,280                0              0              0
    Increase (decrease) in other liabilities                     0              0              0              0              0
    Cashflow from operating activities                    (4,938)       123,622        312,671       (214,294)       249,088

Investing cashflows
    Purchase of PP&E                                     (13,906)        (5,363)       (13,262)               0              0
    Proceeds from sale of PP&E                                  55              0              0              0              0
    Purchase of investments                             (229,862)      (906,559)      (821,971)               0     (314,132)
    Proceeds from sale of Investments                    158,270        727,025        488,940        100,000         75,000
    Cashflow from investing activities                   (85,443)      (184,897)      (346,293)       100,000       (239,132)

Financing cashflows
    Short-term borrowings, new                                   0              0              0              0              0
    Long-term borrowings, new                                    0              0              0              0              0
    Right issue                                                  0              0              0              0              0
    Cash dividend                                                0              0              0              0              0
    Treasury stock                                               0              0              0              0              0
    Exercise of stock options                             78,523         65,164        105,709                0              0
    Cashflow from financing activities                    78,523         65,164        105,709                0              0

Cash, beginning balance                                   56,289         44,431         48,320        120,407             6,113
Net cashflow                                             (11,858)            3,889      72,087       (114,294)            9,957
Cash, ending balance                                      44,431         48,320        120,407             6,113      16,070
Source: Company Documents, Student Estimates

AIM Equity Research Report Competition                                                                                      24
 Association of Investment Management                                                                                                  November 19, ‘04

Figure 23: Key Ratios

                                                        2003A                           2004E                           2005E                           2006E
Market Multiples
P/B ratio                                                  3.3                             3.6                             3.2                             2.9
P/Sales ratio                                             15.4                            16.6                            15.0                            13.9

Debt ratio                                                0.06                            0.05                            0.04                            0.04
current ratio                                             12.0                            14.8                            18.8                            21.1

Gross Margin                                            85.5%                           88.4%                           91.5%                           91.2%
Operating Margin                                        73.9%                           71.8%                           75.2%                           73.7%
Pretax Margin                                           77.9%                           78.1%                           82.4%                           81.0%
Net Margin                                              47.5%                           49.7%                           50.3%                           49.4%

ROA                                                     12.5%                           10.0%                           10.6%                           10.3%
Net Margin                                              47.5%                           49.7%                           50.3%                           49.4%
Asset Turnover                                            0.26                            0.20                            0.21                            0.21

ROE                                                     13.3%                           10.5%                           11.0%                           10.7%
Net Margin                                              47.5%                           49.7%                           50.3%                           49.4%
Asset Turnover                                            0.26                            0.20                            0.21                            0.21
Financial Leverage                                        1.06                            1.05                            1.04                            1.04
Source: Company Documents, Student Estimates

Ownership and material conflicts of interest:
The author(s), or a member of their household, of this report holds a financial interest in the securities of this company.
The author(s), or a member of their household, of this report knows of the existence of any conflicts of interest that might bias the content or publication of
this report. The conflict of interest is…
Receipt of compensation:
Compensation of the author(s) of this report is not based on investment banking revenue.
Position as a officer or director:
The author(s), or a member of their household, does serves as an officer, director or advisory board member of the subject company.
Market making:
The author(s) does not act as a market maker in the subject company‟s securities.
Ratings key:
Banks rate companies as either a BUY, HOLD or SELL. A BUY rating is given when the security is expected to deliver absolute returns of 15% or greater
over the next twelve month period, and recommends that investors take a position above the security‟s weight in the S&P 500, or any other relevant index.
A SELL rating is given when the security is expected to deliver negative returns over the next twelve months, while a HOLD rating implies flat returns over
the next twelve months.
The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but
the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be
used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a
solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with AIM or the
AIM Equity Research Report Competition with regard to this company‟s stock.

AIM Equity Research Report Competition                                                                                                                     25

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