Sizzling Digital Niche Bringing Disney to Life.

With the blowout success of "Toy Story 2," digital animation has become the hottest niche in Hollywood.

But unlike other hot movie genres, which all the studios generally rush to exploit, the digital animation craze is a three-horse race -- and Walt Disney Co. has two of the horses.

Under a 1997 deal, Disney is in line to distribute three more movies by "Toy Story" producer Pixar Inc., not counting additional sequels. The first of those movies, "Monsters Inc.," is slated for release in 2001.

Meanwhile, Disney, never shy about muscling into profitable niches, is beefing up its own in-house digital animation unit. Its first solo-effort digitally animated film, "Dinosaur," is slated for release on the Memorial Day weekend in 2000.

The third horse is the team of DreamWorks SKG and Palo Alto-based Pacific Data Images, which created 1998's hit "Antz." DreamWorks/PDI is now working on "Shrek," which is slated for release in 2001.

The popularity of digital animation couldn't have come at a better time for Disney, whose stock has been on a rebound in recent weeks after months of negative publicity on various fronts. And while one successful movie is hardly the basis for a fundamental corporate rebound, the digital revolution creates several opportunities for the Burbank-based company over the next few years.

"Has Disney ever had an (animated) movie fail?" said David Leibowitz, an analyst with Burnham Securities in New York. "They are the natural."

To date, Disney's success in digital animation has been tied to Pixar -- and a 1997 agreement is far more lucrative for Pixar than was the original deal inked in 1991. Given the success of "Toy Story 2," any subsequent deal will likely be even more lucrative for Pixar than even the 1997 contract.

But the production of "Dinosaur," which is costing anywhere from $175 million to $200 million, shows that Disney does not want to be stuck in a digital animation rut if Pixar jumps ship as soon as its current contract is up.

"I am sure. Pixar will start producing films on their own and send them out to the highest bidder," said Robert Bucksbaum, president of Reel Source Inc., which tracks box-office results. "They could even start their own distribution outfit, although that's less likely."

While Pixar officials declined to comment for this story, Disney officials confirmed that the studio wants to increase its control over the digital-animation process.

"Obviously we are partners with Pixar, but we don't have any investment in their technology," said Robert Moore, executive vice president of operations and finance for Walt Disney Studios. "Disney has traditionally been on the cutting edge of technology. As a company, we had a belief that we need to continue to be on top of the digital-animation capability."

Expect fierce competition among the three digital-animation entities in the months ahead, much like what occurred when Disney/Pixar's "A Bug's Life" and DreamWorks/PDI's "Antz" were released within months of each other.

And Disney's in-house group will be a for-midable contender. The early buzz on "Dinosaur" is good -- Bucksbaum saw a 20-minute preview and described it as "phenomenal."

Disney isn't wasting any time in marketing the movie. An extended-length preview of "Dinosaur" is being exhibited prior to screenings of "Toy Story 2." In the preview, audiences are shown a variety of gee-whiz animation effects, including a charging Tyrannosaurus Rex, a dinosaur stampede, swooping pterodactyls and the Moses-esque trip of a dinosaur egg down a river.

"It's really an exciting project," said Jill Krutick, an analyst with Salomon Smith Barney Inc. "It's going to be a key summer movie."

Bucksbaum agreed. "There's no doubt 'Dinosaur' will make money for Disney," he said. "The promotional tie-ins alone will pay for the production costs."

Meanwhile, the DreamWorks/PDI team is pinning its hopes on "Shrek," a full-length digitally animated feature film based on the children's book by William Steig. Described as a "fractured fairy tale," it follows a swamp ogre and his adventures in a fantasy kingdom, where he eventually falls in love with an equally ugly princess.

While it's still too early for any advance buzz, "Shrek" has a long way to go to match DreamWorks/PDI's first completely digitally animated film, "Antz," which generated $90.7 million at the box office.

As for the next Disney/Pixar entry, "Monsters Inc.," it's a comedy that is "set in the realm of things that go bump in the night, where chaos breaks loose after a hapless monster accidentally lets a human child into the secret world," according to a statement from Pixar.

Regarding the effect that 'Toy Story 2" or "Monsters Inc." will have on earnings and stock price, Pixar likely will feel it more than Disney.

"The stock will ebb and flow based on movie euphoria -- and the success of 'Toy Story 2' will have a much bigger impact on their bottom line," said Krutick. "For Disney, 'Toy Story 2' is one piece of a very complex puzzle. They're much more diversified."

More significant factors for a 10 percent rise in Disney stock include the agreement to open a theme park in Hong Kong, the decision to re-release several classic Disney movies on home video and DVD, and the success of "Who Wants to Be a Millionaire" on Disney-owned ABC.

Nevertheless, some analysts estimate that Disney could wind up with profits of $500 million on "Toy Story 2," not exactly inconsequential even for a company of Disney's global proportions. "Disney is in a tremendous position given the success rate they've had with Pixar," Krutick said.

Disney's partnership with Pixar dates back to 1991, when the two companies signed a three-picture deal. Pixar, seeking Disney's distribution prowess and financial backing, successfully pitched the plot for what ultimately became the original 'Toy Story."

"It was an easy choice for Pixar," analyst Leibowitz said. "Choosing Disney as your distributor over other companies is like choosing to have Mark McGwire as your batter in the World Series instead of your relief pitcher."

Disney, on the other hand, was attracted by Pixar's track record with short animated films and by the talent of company executives.

In 1986, Pixar was purchased from Lucas-film Ltd. by Steve Jobs, founder of Apple Computer. Two years later, the company won the Academy Award for Best Short Animated Film for "Tin Toy."

The director of "Tin Toy," John Lasseter, went on to direct 'Toy Story" and received an Academy Award for Special Achievement.

"Ultimately, these kind of deals work best when they start from a great idea that people are excited about developing," Disney's Moore said. "People here have a tremendous amount of respect for John Lasseter and his creative instinct and the technology that Steve (Jobs) has been developing. We thought, 'This is a group of people that have a great idea, are great storytellers and have great technology. These are the kind of people we want to partner with."

Analysts estimate that under the original 1991 contract, Pixar received somewhere between 10 percent and 15 percent of the gross profits of the films.

"The 1991 contract was a much more traditional studio/producer deal," Moore said. "Disney did 100 percent of the financing... and Pixar took no risk and in exchange got a more modest back end of the profits. In 1997, it was reworked so that Pixar became a partner with Disney and put up their own capital in the film."

Giving Pixar clout in negotiating that 1997 five-picture deal was the success of "Toy Story" and Pixar's barn-burning IPO the same year.

Under terms of the 1997 deal, Disney and Pixar split the marketing and production costs for each film evenly. The two companies also split gross profits, after Disney takes a distribution fee off the top. Backing put that distribution fee, the profit split translates to about 68 percent for Disney and 32 percent for Pixar, industry sources said.

                        Digital Animation Explosion
COMING ATTRACTIONS
                     Praducer/        Scheduled
    Movie           distributor        release
  Dinosaur             Disney     Memorial Day 2000
Monsters Inc.       Pixar/Disney        2001
    Shrek          PDI/DreamWorks       2001
                           DIGITAL HITS TO DATE
                Producer/             U.S. box office
Movie          distributor   Released   (millions)
Toy Story     Disney/Pixar     1995        $192
Antz         PDI/Dream Works   1998          91
A Bug's Life  PixarlDisney     1998         163
Toy Story 2   Pixar/Disney     1999         325 [*]
(*.)Estimate
Sources: Salomon Smith Barney, Reel Source
Inc., Disney, PDI, Pixar, imdb.com