A Spotlight on Gemstar and Pixar


By Ronald Grover It would be hard to find two companies facing more different situations than Gemstar-TV Guide and Pixar. Gemstar (GMST), the once high-flying producer of those on-screen television guides and publisher of TV Guide, recently settled a Securities & Exchange Commission investigation, although its former chairman still faces a lawsuit filed by the federal watchdog.

On the other hand, Pixar (PIXR) is among Hollywood's most sure-footed filmmakers, with a string of box-office blockbusters like Finding Nemo, Monsters, Inc. and Toy Story. And Pixar, which is 53.1%, owned by Apple (AAPL) Chairman Steve Jobs, is also a hit with other studios, which are bidding to distribute its computer-generated flicks if the animation outfit breaks away from Disney (DIS) some time next year.

Still, as they prepare to announce their second-quarter earnings on Aug. 5, both outfits are winning support among Wall Street analysts. Today, 7 of the 14 analysts who follow Pixar rate it a buy or strong buy, vs. 5 just two months back. The number of analysts with a buy or strong buy on Gemstar has doubled in the last month, to four, among the nine who follow the Pasadena (Calif.)-based outfit.

NEW DEALS. Gemstar, which owns the rights to those on-screen guides that help couch potatoes select the programs they want, disappointed analysts earlier this year, when it lowered its 2004 operating income by 27%, citing continued weakness at its magazine, higher legal costs, and increased investments to create a TV Guide channel. The market reacted by slashing a further 17% from Gemstar's already depressed stock, driving it down to $4.07 (on Aug. 3, it closed at $4.42). Rupert Murdoch's News Corp. (NWS) owns 42% of the company, so it's no surprise that the man behind an aggressive revamping is CEO Jeff Shell, a former News Corp. strategic planning executive.

Shell has pushed Gemstar to sign new deals licensing its technology for set-top boxes, digital recorders, and other devices, and with cable- and satellite-TV operators, which carry Gemstar's new TV Guide cable channel and use its on-screen technology.

Such deals have analysts thinking Gemstar may finally be ripe for a turnaround. Blaylock & Partners' Todd Mitchell, who rates Gemstar a buy, figures it will report a small $1.2 million loss in the quarter, or less than a penny a share, vs. a $43.4 million loss in its first quarter of 2003, or 11 cents a year ago. In its first quarter, Gemstar reported a $39.8 million loss, or 3 cents a share. A big part of that improvement, says ThinkEquity Partners managing director John Tinker, comes from the cable and satellite division's 13% hike in revenue, to $47.9 million. ThinkEquity rates Gemstar a buy, with a 12-month price target of $8.

BETTER THAN EXPECTED. American Technology Research analyst Rob Sanderson, who also rates Gemstar a buy, figures it will lose just 1 cent per share, in large part because he sees reduced legal expenses and stronger earnings growth from licensing to cable and satellite outfits. He also notes that it has about $500 million in net cash on its books, and sees cash flow beginning to climb from a negative $1.8 million in 2003 to $75 million by yearend. "We like [Gemstar] as a turnaround story under new management, with several strong core businesses," Sanderson writes. He also sees "enormous" opportunity down the road for Gemstar to sell ads on the guides that it licenses to makers of consumer electronics.

The picture is a lot less complicated for Pixar, which has seen its earning more than double in the last four years, as it has geared up film production and continued to generate revenues from home video, DVDs, and consumer products spawned from its movies. Analysts generally expect Pixar to earn 38 cents a share, well above the guidance of 30 cents -- and there are some who believe that it could do even better.

Jessica Reif-Cohen, a Merrill Lynch analyst, forecasts second-quarter earnings of 41 cents, with a 29% hike in operating earnings to $37.6 million, up from $29.2 million a year ago, due to the strong international sales of Finding Nemo on video and DVD. Reif, who rates Pixar a buy, estimates that the stock will be trading at $78 a share within 12 months. It closed on Aug. 3 at $67.82.

DISNEY FACTOR. Not all analysts are as sanguine as Reif-Cohen. Morgan Stanley's Richard Bilotti figures Pixar is worth only about $50, rating it underweight, in large part because he figures that investors enamored with the string of hit movies are "overestimating Pixar's long-term earnings power under a new co-production agreement." Indeed, Bilotti and others will be interested in hearing from Pixar executives of its progress in obtaining a new agreement with a studio to distribute its product. Pixar's current deal with Disney (DIS), which gets half the revenue and a 12% distribution fee in return for putting half the cost of each film, expires in 2005.

Analysts may be disappointed because Steve Jobs, Pixar chairman and majority shareholder, won't be on the conference call. Jobs, who has been negotiating for a far more generous deal with the likes of Warner Bros. (TWX) and Sony Pictures (SNE), is recovering from recent cancer surgery that removed a tumor from the 49-year-old tycoon's pancreas. In an e-mail to employees, he said he is doing well and that doctors expect him to make a full recovery (see BW Online, 8/2/04, "Apple's Cancer Scare").

Still, a lot of Pixar's future growth may depend on the deal it signs. Hollywood insiders say that Jobs wants a more generous deal than his current Disney contract, which would allow Pixar to cut its distribution fee to 6% and keep all the remaining profits. To get that lower rate, Pixar would likely have to put up a larger percentage of each film's costs, which can run to $120 million. Pixar currently has more than $700 million in cash and receivables on its books.

ONE BAD MOVIE... That could prompt Pixar to increase output beyond the current rate of a new film every 12 months to 18 months, figures Cowen & Co. analyst Lowell Singer, who rates the stock a buy and says its fair market value is $80. Singer predicts that Pixar will generate $27.7 million in earnings in the quarter, about 29 cents a share. That would represent a 14% decline on a year ago, despite heavy overseas sales of Finding Nemo videos and DVDs.

Singer does raise one troubling prospect: If Pixar doesn't strike a deal with Disney and decides to take a larger stake in producing its own films, "one or two disappointing films could severely hamper the company's economic position." If that were to happen, "a new set of risks could emerge," he adds. In that case, the company that made Toy Story could have to tell a whole new story to investors. Grover is Los Angeles bureau chief for BusinessWeek


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