The film opens in Hollywood, California, circa 1939, in which Danny sends out an invitation to Sawyer to be in the next Pooh play. The film fast forwards to Cartoon All-Starland and the 100 Acre Wood, 51 years later (1990), where Chistopher Robin does his usual running gag of introducing the film.
Bastian Bux is having troubles at home: his father, Barney, cannot relate to him—his busy workload is keeping him from spending time with his son and Bastian's fear of high places is hurting him on the swim team. Bastian flees from his problems to an old bookstore where he reunites with Pooh and the gang, when after picking up the NeverEnding Story book and meeting Matt and Metalgarurumon, he hears the Childlike Empress and her 3 pets Lucky, Rolly and Cadpig telling him that he is needed to save Fantasia.
Upon landing in Fantasia, he reunites with Atreyu and meets 4 new character, an anthropomorphic talking bird named Nimbly as well as Spyro, Sparx, Hunter, and the Tiny Toons. Characters from the previous film, such as Falkor and Rock Biter, have minor roles in this film. Bastian now faces "the Emptiness", and he is soon manipulated by the evil sorceress Xayide, her master Red the Dragon and her magical army of mechanical giants created and led by the resurrected yet hollow SpaceGodzilla. Red and his apprentice have a sinister plan for Fantasia and the Childlike Empress, but much of the film involves them persuading Bastian to forget about his mission and instead make a series of silly wishes. Each wish that Bastian makes causes him to lose a memory, and when he loses all memories he will not remember Fantasia and the Emptiness will take over.
Meanwhile, Barney is out looking for his son, finding little help from the police or the bookstore owner, Mr. Koreander. He finds the NeverEnding Story book and is surprised to see his son's exploits unfolded on the page. As he follows Bastian and company's journey through the book, they discover that Xayida got them going around in circles making it believed that she doesn't want them closer to the Ivory tower (although Bastian was too clueless to know it.) Suddenly, they meet an Furry Cat tamer named Dave Felis and his Digimon Renamon who are friends to Matt, Saphire and Metalgarurumon. That evening, Atreyu and the others conveys their concerns to Falkor and realizes they must stop Bastian before Xayide's hold over him becomes too strong to break. This leads to a fight between the two boys ending with Bastian accidentally sending Atreyu over the side of a small cliff and Matt having a sickness which made him fell asleep. As Atreyu's and Matt's lifeless bodies lies at the bottom of the cliff, Bastian is momentarily shaken by the events, but then shouts to them that they brought their deaths on themselves. He returns to Xayide, only to find the machine that has been collecting the orbs containing his memories and finally realizing the sorceress' evil intentions to power up SpaceGodzilla. Bastian then sees Falkor flying away with Atreyu's body while the others chase after MetalGarurumon with Matt's body. He eventually catches up to them and after expressing regret for inadvertently killing his friend, he sacrifices his memory of his beloved mother to wish Atreyu back to life and make Matt feel well, in which the others arrived to realise that Metalgarurumon (who had been running off with Matt's body) didn't eat Matt. Now Bastian has only one wish (and only one memory - his father) left. Xayide appears and urges him to use his final wish to return home, but instead turns the tables on Xayide by wishing for her to have a heart. The overwhelming sense of suddenly being able to feel emotion proves to be too much for Xayide and the evil sorceress as MetalGarurumon and Renamon use Metal Wolf Claw/Diamond Storm attacks to dispose her in a blast of light, causing Red to flee in the shockwave, but not seen; and with the destruction of SpaceGodzilla and his Giants, Fantasia is restored in all its glory. After being thanked by the Childlike Empress and with the verbal encouragement of his father, Atreyu and Falkor, Bastian is able to face his fear of heights by having him and his friends jump off a high cliff, thus returning home safely. Metalgarurumon took Matt, Dave Felis, and Renamon back to the home; and from that point on, Alvin, Baby Kermit, Baby Bugs Bunny, Pooh and all their friends trusted Metalgarurumon.
- This marks the return of Danny and Sawyer from Winnie the Pooh, Alvin Seville, Baby Bugs, & Baby Kermit Meets The Seventh Brother.
- Dennis The Menace and his friends (animated), Danny, Sawyer, Matt, MetalGarurumon, Dave Felis, Renamon, Buster Bunny, Babs Bunny, Plucky Duck, Shirley the Loon, Hamton J. Pig, Fifi La Fume, all their friends, Mary Melody, Spyro the Dragon, Sparx and the rest of their cartoon characters will guest star in this film.