A Picture Deal’s Life

The mood was jovial as Walt Disney Co. chief Michael Eisner and his guest, Pixar Animation Studios head Steve Jobs, watched Game 5 of the World Series from a luxury box at Pac Bell Park in San Francisco. Sitting side by side, the two men laughed together, bantering and talking baseball.

For the moment, it seemed, both were on the same team.

But behind the lighthearted atmosphere, away from the playing field, the two industry titans are locked in their own kind of Hollywood gamesmanship, with hundreds of millions of dollars riding on the outcome.

“It’s a question of who’s going to blink first,” said Merrill Lynch analyst Andrew Slabin.

During the last decade, Burbank-based Disney and Pixar have forged one of the industry’s most successful partnerships. They have made a string of revolutionary computer-animated hits -- “Toy Story,” “Toy Story 2,” “A Bug’s Life” and most recently “Monsters, Inc.” Three more are coming under an agreement that gives both companies an even split of the profits.

The problem for Disney is that, along the way, Pixar has gone from rookie to superstar.

With an impeccable track record and a strong balance sheet of nearly $300 million in cash, Jobs has made it clear to Hollywood and Wall Street that he will begin entertaining offers from rival studios early next year and could potentially part ways with Disney. If he chooses to stay with Disney, he will push for a deal that would give Pixar all the profits and pay Disney only a distribution fee to release its movies, according to sources close to Jobs.

Either way, Disney’s movie earnings could take a substantial hit, underscoring just how dependent the studio has become on Pixar in recent years.

Disney has reaped nearly $500 million in profits from the Pixar movies from 1998 to 2001, accounting for an estimated 45% of the studio’s operating income in that period, according to a recent report by Prudential Securities. Over that same time, Disney’s own animation unit produced such box-office disappointments as “Atlantis: The Lost Empire” and “The Emperor’s New Groove” and retrenched by slashing hundreds of jobs and salaries. It was only this summer that Disney scored with its own hit, “Lilo & Stitch.”

Disney’s relationship with Pixar, which is uncertain beyond 2005, has attracted increasing scrutiny as investors grow impatient with Disney’s financial struggles, particularly at its ABC television network and theme parks. Eisner has been under heavy pressure from powerful board members and shareholders to boost Disney’s stock price, which has been pummeled in the last two years. Disney shares were up 33 cents at $17.03 in New York Stock Exchange trading on Friday.

No Discussions Yet

So far, Disney and Pixar are not negotiating, prompting some analysts to question whether Eisner is moving too slowly on an arrangement that is so vital to his company.

“To lose [Pixar] would be a huge strategic blow and a financial blow for Disney,” said Paul Kim, an analyst with Kaufman Bros.

Pixar’s enviable success streak appears to give it the upper hand in negotiating any new deal. Under the current contract, Pixar produces the movies and Disney markets and distributes them. The two evenly share costs and profits. In addition, Disney gets a distribution fee that averages 12.5% of a movie’s revenue.

Still, Pixar needs Disney, analysts say. Pixar would be hard-pressed to find another partner with the brand name, marketing muscle and global reach in family entertainment that has made Disney an industry leader in animation for decades. Nor does any other studio have the marketing prowess to cross-promote family movies in its theme parks, retail stores and cable and network television outlets.

“If you go to another studio, you may not have those capabilities up and down the food chain,” said Kim, of Kaufman Bros.

Pixar shareholders also may be cool to the idea of breaking up such a financially successful partnership. Emeryville, Calif.-based Pixar is expected to report strong third-quarter earnings Monday. The studio’s success is even outshining Jobs’ main business endeavor, Apple Computer Corp., which just posted a fiscal fourth-quarter loss of $45 million due to soured investments and a decline in shipments of its flagship Macintosh computers.

Despite Pixar’s successful collaboration with Disney, their marriage has been clouded by an underlying friction that’s existed for years between Eisner and Jobs, a factor that analysts suggest could complicate future negotiations. Both men declined to be interviewed.

The specter of divorce first emerged last year with a fight over the third installment of the lucrative “Toy Story” franchise. A clause in the contract says sequels don’t count toward films Pixar must deliver, but Jobs has argued that Eisner should let “Toy Story 3” count as part of its five-picture deal. The dispute has left the project in limbo.

Tensions flared again this summer when Eisner offended Jobs over remarks he made in Washington about digital piracy by suggesting Apple was promoting the illicit practice with its slogan: “Rip. Mix. Burn.”

‘Never Been Better’

The friction has since eased enough for Eisner to invite Jobs to the World Series. The chairman of Disney Studios, Richard Cook, insists the working relationship between the two companies “has never been better.”

“We’re committed to staying together,” he said.

Still, without any negotiations in sight, some analysts believe that Disney could find itself at a disadvantage. The company, they say, needs to step up to the plate to swat away potential competitors. “You don’t want to be in a position of countering someone else’s offer,” said Katherine Styponias, an analyst with Prudential Securities.

Jobs bought Pixar in 1986 for $10 million from director George Lucas and is its biggest stockholder, with a 60% stake. Disney has a minority interest, holding less than 5%.

In 1991, Jobs and Eisner formed their movie-making pact, one that has changed significantly since then. On their first release, “Toy Story,” Pixar earned less than 15% of the profits. The 1995 hit comedy heralded its director, John Lasseter, as the next Walt Disney and established Pixar as the pioneer of the digital animation age.

Five-Picture Pact

Two years later, with its newly earned clout, Pixar negotiated its lucrative five-picture deal in which it became equal partners with Disney. The first film under the deal, “A Bug’s Life,” brought in $362 million worldwide, and the second, “Monsters, Inc.,” $530 million.

Disney’s profits could be greatly reduced if Jobs pursues a deal he favors, which is similar to the one Lucas has with 20th Century Fox. The filmmaker reaps all the profits from his lucrative “Star Wars” franchise and pays Fox an 8% to 10% distribution fee to release the movies.

Whatever happens, both sides are heavily posturing, making it known that success can be found outside their partnership.

Eisner has sent mixed signals about whether he would be willing to allow Disney to be relegated to a distributor’s role. At a Sept. 13 meeting with investors and analysts in New York, the Disney chief praised Pixar creative chief Lasseter and said that “a Lucas-type deal” was possible. On other occasions, however, Eisner has insisted that Disney would not be a distribution channel for rent.

Eisner suggested Disney is prepared to develop its own sequels to the “Toy Story” and “Monsters” hits if Pixar were to go its own way -- a scenario that even Disney executives concede is improbable. Eisner also has touted Disney’s recently struck deal with John Williams, one of the producers of “Shrek,” to make computer-animated movies, although no one is suggesting it’s a replacement for Pixar.

“The intended message was: ‘If you think you’ve got us over a barrel, think again,’ ” Styponias said.

For his part, Jobs already has begun boasting to analysts that Pixar has many options when it comes to landing a future deal with another studio. Although he cannot begin negotiating with other studios until next spring, when Pixar delivers the undersea adventure “Finding Nemo” to Disney, he has let it be known that a number of suitors have expressed interest. Those include Sony Corp.’s Sony Pictures and Metro-Goldwyn-Mayer Inc.’s MGM Studios, sources said.

Pixar Faces Risk Too

As Jobs pushes for a Lucas-type distribution deal, analysts caution that such an arrangement is not without risk for Pixar given that its movies cost about $125 million each to produce and an estimated $80 million to market worldwide. One flop could be devastating to a company such as Pixar, which averages just one movie every 18 months and is not diversified like Disney.

“It’s inevitable that Pixar is going to stub its toe,” said Merrill Lynch’s Slabin.

That may be hard for Jobs to fathom because Pixar’s animated movies so far have totaled more than $2 billion in worldwide box-office receipts and hundreds of millions more in home video, DVD and merchandising sales. Although the future of the Disney-Pixar relationship remains uncertain, the turmoil has not affected the day-to-day workings of the partnership. Indeed, Pixar creative guru Lasseter, a former Disney animator, has helped foster close ties between the studios’ top creators.

For now, the partners are focused on prepping “Finding Nemo,” due in theaters in May, and boosting sales of their recently released “Monsters, Inc.” DVD, which was heavily promoted during the World Series games.

In TV spots that aired between innings, Mike and Sully, the animated stars of “Monsters,” were featured playing baseball.

The big question is whether their corporate parents are willing to play ball as well.