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After stumbling, discovery, one of cable’s great successes, turns to its programming roots 1/13/2006 07:00:00 PM Eastern

At a Discovery Communications Inc. board meeting last fall, Billy Campbell, the head of the company’s networks, caught an earful from one of the largest shareholders. Bob Miron, president of 25% shareholder Advance/Newhouse, protested that some new programming is harming the company’s brands. He challenged one of Discovery’s few recent successes, Dirty Jobs, in which the host takes a new repellent job each week. Recent episodes covered a pig farmer and horse inseminator.

“He told Campbell, 'This could be on any network,’” says one Discovery Communications Inc. (DCI) executive familiar with the incident. Miron also dislikes Miami Ink, a new TLC show set in a tattoo parlor.

Campbell confirms the conversation, saying Miron wants to ensure that Discovery strikes a balance between the brand and the ratings.

The board member’s pointed pronouncement reflects the plight of one of the most successful brands in television, a $2.7 billion-a-year enterprise that turned 20 last summer. Discovery Communications programs 17 U.S. networks, mostly digital cable channels, and 70 overseas networks seen in 160 countries. But its once roaring growth has slowed. The company’s four largest networks are in a ratings slide, and its two main engines—Discovery Channel and TLC—are misfiring at the same time. Last year, U.S. ad sales were flat compared with 2004.

Top Discovery executives acknowledge that they lost their way in programming and became addicted to genres that once seemed sure-fire but abruptly misfired: boys-with-toys on Discovery and makeovers on TLC.

The crisis is more fundamental than the fading of a couple of hit shows. Prime time audiences are smaller than in the days before anyone had ever heard of Discovery’s Monster Garage or TLC’s Trading Spaces. Each network’s Nielsen ratings are lower than they were in 2001, even though distribution has risen 15%. Since first quarter 2004, TLC has lost 40% of total viewers and 44% of viewers in the 25-54 demo that the network pushes to advertisers. Discovery’s ratings have shrunk by 20% in total viewers and by 29% in the demo. Both channels are losing traction against the ever popular off-network fare such as CSI on Spike and various Law & Orders on TNT and USA.

Discovery’s dilemma spotlights a problem facing many cable programmers. As networks “top out,” or reach as many cable and satellite subscribers as possible, they are increasingly reliant on advertising alone for growth. So misjudging the fickle tastes of viewers can trigger a severe financial crunch—even for large, diversified programmers.

DCI’s shareholders are getting antsy. Miron, who runs seventh-largest cable operator Advance/Newhouse, was only the most prominent of viewers who complained that some of Discovery’s brash programming conflicts with its wholesome brand image. And alarm bells went off throughout the company in October when John Malone, who controls 50% of DCI, came to town. The chairman of Liberty Media and affiliate Discovery Holding asked for three days of meetings at the programmer’s Silver Springs, Md., headquarters and met not just with top executives but with general managers of individual networks as well.

The crunch focuses a harsh spotlight on two executives: Judith McHale, longtime president of Discovery Communications and CEO for the past year, and a more recent arrival, Billy Campbell, president of Discovery Networks U.S., who’s in charge of the company’s domestic networks. With the company’s growth stalled like that of media giants Disney and Viacom, both outsiders and insiders are asking if management that’s right for a growth company is the right management for a mature one.

At the moment, the answer from DCI’s top executives and, most important, to its powerful shareholders, is yes. McHale expresses confidence that Discovery and TLC’s problems are being solved and their ills offset by the continuing strength in DCI’s international operation.

The company is brewing plans for a spring offensive, including a substantial marketing overhaul of TLC. McHale and Campbell are relying more heavily on consumer research to help both networks find their groove. TLC will be broadened and Discovery will return to its science and nature renown, a mantle that rival National Geographic Channel is trying to steal.

“We’re so well-positioned to play on so many of these new platforms that are coming out,” says McHale, “that the future looks really bright for us.” And because DCI has for years been ruthless about securing virtually all rights for programs it develops, its networks are in a strong position to exploit that growing appetite for short-form TV on cellphones and other mobile devices. McHale is further excited about a new education unit adapting the networks’ content to help teachers, students and parents.

She also expresses confidence in Campbell, the man in charge of the networks in the midst of a slide. The former Warner Bros. Television and Mirimax executive was hired in 2002 to inject an entertainment sensibility into DCI’s U.S. networks.

Shareholders are pressing for change, not necessarily a management change. Says Jim Robbins, retired president of Cox Communications, which owns 25% of DCI, “Here’s an entity that’s 20 years old, and it’s sort of looking at the mirror, saying, 'Where do we go from here?’”

He cautions that DCI should be examined in the context of 20 years. “This thing has been a rocket ship,” he says. “No rocket ship continues to go up forever.”

Chairman John Hendricks, a onetime fundraising consultant, launched Discovery Communications in June 1985 and quickly became one of the cable industry’s great success stories. He pushed the idea of science and nature “edutainment” shows, which he thought were the strongest part of public television—and which he believed had market value.

At the time, basic cable was dominated by old sitcoms and marginal sports. Discovery’s family-friendly, educational bent gave cable operators something upbeat to pitch to subscribers.

AROUND THE WORLD

After a brush with financial disaster, Hendricks secured backing from cable operators including John Malone’s Tele-Communications Inc., Cox Communications and Advance/Newhouse. Malone moved his 50% stake to Liberty, then spun it off to new company Discovery Holding. Cox and Advance remain shareholders.

Hendricks expanded Discovery around the world. Although international operations have turned profitable, DCI remains reliant on the U.S. networks, which, according to Bear Stearns media analyst Bryan Goldberg, account for 64% of its $2.7 billion in 2005 revenue and 89% of operating cash flow.

The company hit a new stride at the beginning of the decade. After acquiring TLC on the cheap and nurturing it for a decade, DCI found explosive success with Trading Spaces, a home-makeover show that became a ratings and cultural phenomenon. Discovery Channel scored with extreme car-makeover show Monster Garage, which wasn’t as giant a hit but fueled strong earnings.

Ratings success translated into financial success. From 2002 to 2004, Discovery’s U.S. networks averaged 22% growth per year in revenue and operating cash flow. Then, growth abruptly stalled. Once Discovery and TLC found hits, they repeated them heavily. Rather than using the top shows to promote a range of programming, McHale, Campbell and their team imitated sure successes over and over. Trading Spaces spawned While You Were Out and Town Haul. Monster Garage gave birth to American Chopper, Monster House and American Hotrod.

The new shows turned off some longtime viewers. TLC was built in part on heartwarming shows that chronicled people’s lives, like A Baby Story or A Wedding Story. Some newer makeover shows were a bit cruel, like What Not To Wear, which followed candidates with hidden cameras.

COOL BUT COARSE

The garage shows often highlighted cool gear but were often coarse and didn’t offer the kind of learning that was Discovery’s hallmark. Charley Humbard, now president of Gospel Music Channel, “lived and breathed and bled Discovery” in his years at the company, starting up international and U.S. digital networks. But he bristled over gruff motorcycle show American Chopper. “I couldn’t watch it with my kids, because there’s too much swearing,” he says. “This is Discovery?”

Because many of the new viewers hadn’t been introduced to anything interesting, they left—in droves.

In October—a month DCI executives had hoped would mark a comeback—TLC ratings shriveled by 14% from a year earlier; Discovery’s audience shrank by 19%. TLC continued to fall in December, and Discovery posted mixed results, up in total audience but down in the target 25-54 demo.

Campbell saw the over-reliance problem coming but didn’t expect it to hit so abruptly and on both core channels. “As a programmer, it’s sort of that moth-to-the-light mentality,” he says. “If something works, program it. The audience is telling you that they like it.”

Discovery’s crunch is far from a financial crisis. Revenue—even at the U.S. networks—is still growing at a rate that executives at broadcast networks or TV stations would envy. What has troubled investors is that the rate of growth has plunged so abruptly. Instead of growing 20% or so, analysts expect the U.S. networks’ revenue to increase 9% for 2005 and 6.5% for 2006.

“DOUBLE HIT”

The culprit: virtually no growth in advertising. License fees are still rising, thanks to their immunity from Nielsen ratings and Discovery’s array of small digital networks. The foreign operations offset some of the pain.

Bear Stearn’s Goldberg has modest expectations for Discovery and Malone’s Discovery Holding. Merrill Lynch’s Jessica Reif Cohen recently put a “sell” rating on Discovery Holding. She expects Discovery to suffer a “double hit” to earnings “from relatively weak advertising and increased programming expenses.”

Hendricks and McHale have already cleaned house, blowing out the general managers of five major networks and replacing three with British execs. Production units have been stripped from individual networks and centralized, a move aimed at streamlining program development. In ad sales, DCI is taking the opposite approach, reassigning salespeople to represent just a couple of networks rather than cross-selling the channels.

Still, the company is looking for focus. In plotting a programming overhaul, TLC last fall put more than 100 projects in the pipeline.

Discovery Channel just scored a coup by luring ex-ABC Nightline anchor Ted Koppel to produce shows. “We’re in the process of reinventing ourselves,” says Jane Root, VP/general manager of Discovery Channel for 18 months. She is part of the British invasion of TV executives. She previously was controller of BBC Two.

One major tactic is to increase the prominence of neglected genres. Anthropology, for example, a genre on which Discovery was built, comes back as Going Tribal, in which the “extreme explorer” host lives with tribes in remote areas, hunting wolves, drinking cow’s blood, etc.

The huge ratings success of a re-enactment of one of the 9/11 hijackings, The Flight That Fought Back, is encouraging Discovery to push more into what Root calls “recent history.”

Discovery’s return to its roots is apparent in I Shouldn’t Be Alive. Launched in October, the series recounts the tales of people caught in calamities, such as storms, shark attacks and ship­wrecks.

It was pitched to Discovery as an adventure show and a year earlier probably would have aired that way. But in consulting viewers, executives realized that it lacked a “Discovery element,” so producers wove in more information such as specific survival skills.

One successful show, Myth­Busters, already fits that mold.

Hendricks believes Discovery will right itself and, more important, will dominate on several platforms. Consumers will increasingly face digital and VOD “default screens” of just a few channels.

“How many brands can you see on that first screen?” he asks. “It’s a fight for the menu position.”

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