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Executives

Andrew C. Warren - Chief Financial Officer and Senior Executive Vice President

Analysts

Benjamin Swinburne - Morgan Stanley, Research Division

Discovery Communications, Inc (DISCA) Morgan Stanley Technology, Media & Telecom Conference February 25, 2013 11:45 AM ET

Benjamin Swinburne - Morgan Stanley, Research Division

Can you hear me? Yes. All right. Good morning, everybody. My name is Ben Swinburne, Morgan Stanley's media analyst. And let me first get rid of my legal obligation, please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures appear on the Morgan Stanley public website or at the registration desk. And we're really excited to kick off the media portion of the conference with Andy Warren, Senior Executive Vice President and CFO of Discovery. Andy joined Discovery in March 2012 from Liz Claiborne, where he was CFO since 2007. And in his first year in the company, Andy led the $1.7 billion acquisition of SBS Nordic, which is the largest acquisition in Discovery's history. Andy, thanks for being here.

Andrew C. Warren

Of course. Thanks. It's good to be here.

Question-and-Answer Session

Benjamin Swinburne - Morgan Stanley, Research Division

So with a year under your belt, maybe you could reflect on your experience at Discovery so far. And looking forward, what are the big kind of growth initiatives you and David and the team are focused on?

Andrew C. Warren

Sure. Well, good morning, everyone. Really, it's been a great first year. I mean, I love the company, I love the culture, it's been a great year so far. Although I'd say as far as early impressions or takeaways, first of all, our Board is extremely long-term focused. And it helps the fact that they are some of our largest shareholders, but they do have a very long view on creating shareholder value, and it's one of the reasons why we take the long view we do on content. That's why we're able to build out international platforms and infrastructure we have. It's why we're able to launch channels like ID and Destination America where maybe there's a short-term margin compression, but you really get a chance to take a long view on asset creation and build some great channels like ID is today. So clearly, the Board's long-term view is very helpful. Secondly, I obviously got to know the management team extremely well, and the experience and gravitas of that team is off the charts. You look at John Hendricks, who founded the company, is still very involved. David Zaslav who's been involved for over 30 years in the cable space, fabulous leader. Mark Hollinger, who runs international business, no one knows, I think, international as well as Mark does, such granularity across all of the markets. And you look at Joe, Head of Sales, he's led sales organizations for over 20 years. You look at Bill leading our affiliate team, he's been doing this for Discovery for 25 years, he just has an incredible understanding of that marketplace. And from the content side, when you look at Henry Schleiff and Eileen O'Neill and Marjorie Kaplan, I mean, these people have been in the content-producing space for, in some cases, over 30 years. So the experience and the knowledge and the passion that these people have for Discovery is pretty impressive. As far as the strategy, Ben, I mean it really comes down to -- look, our strategy is to be the #1 pay-TV platform company in the world and the best content company in the world. We believe in the pay-TV model. We are very focused on really 3 things: driving global revenue growth; expanding our margins; and really significantly increasing our free cash flow per share. Those are our biggest metrics that we focus on.

Benjamin Swinburne - Morgan Stanley, Research Division

Great. Usually, you guys mention nonfiction in that description. Did you drop that on purpose?

Andrew C. Warren

No. No. Look, it's still very much our core. I mean it's still very much the core of who we are and who we'll always be. But I tell you, we have broadened our content offering, and it's an important part of reaching a broad audience, it definitely gets us exposure to a broader ad base, but clearly, nonfiction is still very much our core.

Benjamin Swinburne - Morgan Stanley, Research Division

That's a good segue to SBS. Doubling down in Europe right now, you probably surprised a lot of people. Why do you guys think it was a good deal to do? I guess it hasn't closed officially yet. But why are those assets attractive to you? And how much does scale help you in that market? And maybe talk a little bit about the synergies that you guys expect.

Andrew C. Warren

Well before I get into SBS specifically, let me talk about it from a finance point of view, how I look at every deal that we do. Every acquisition we do, there are 3 critical criteria that they all have to meet. First of all, they have to be EPS and free cash flow per share accretive day one. Second of all, we have to buy them in a multiple that's less than our trading multiple, and ideally below 10. And third, and most importantly, the un-levered IRR, in every acquisition we do, has to be at least in the low teens. And so every deal we've done has achieved those 3, the only one that didn't is Revision3, but that's a very different kind of asset that we've bought, but every other deal we've done has met those 3 criterion. But as far as assets specifically, look, it did a -- it is a leader in the Nordic space. It has over 30% share in Norway, it has over 20% share in Sweden and Denmark and almost 20% share in Finland. The combination of our 2 assets and our 2 companies, great leadership teams, great ad sales, there clearly are some good costs, and even tax synergies, that we have with that asset that we're working through now. But it would absolutely be accretive day one, and it will be a big piece of our growth story.

Benjamin Swinburne - Morgan Stanley, Research Division

What does the acquisition tell shareholders about your content outlook? Moving away from nonfiction and descriptive, and then maybe you could touch on Eurosport and the sports piece too?

Andrew C. Warren

Look, I want to be very clear. We're not moving away from nonfiction. While this is broadening for us, it absolutely still gives us an opportunity to broaden our demographic. It gives us ability to broaden the ad sales base which we currently attract. Look, these are extraordinarily good assets, with extraordinarily good reach. When you look at Eurosport, while sports is very unique for us, Eurosport is very unique in that they really are more affinity-sports related, it's more skiing and cycling and tennis, golf. So it's not the real expensive, soccer league rights. But if you look at the combination of Eurosport and Discovery, I mean, those are 2 of the most relevant male-oriented content, pan-European. So Eurosport is in 59 countries, reach 130 million subscribers. So, no -- they've been a single pan-European distribution offering. It's a combination of us now going to market together. We have much more local ad sales capabilities and talent than they do, they are more pan-European. So the combination of these 2 big male-content companies, a combination of our being localized sales, their being pan-European. I mean, there's lot of synergies and a lot of opportunity to really leverage the 2 offerings.

Benjamin Swinburne - Morgan Stanley, Research Division

And we'll pause to give you opportunity to just talk about the Eurosport transaction, because you just bought a stake in that business, right?

Andrew C. Warren

Yes. It's a very unique structure, as some of you may have seen. It's a -- we bought in a 20% stake with TF1, so we actually had our first Eurosport board meeting last week, with the combination of Discovery and TF1. Very productive, very long-term oriented. But the deal is unique in that we have an opportunity in early 2015 to buy a majority stake, to buy an additional 31%, '15, at the price that was negotiated for the 20% stake and then the additional 16% at a price to be determined based on evaluation. But the fact we had that call option ability in 2 years, we have a kind of a 2-year window to understand the asset, understand the capabilities of how we can combine our strengths and how we combine our Pan-European presence. And if all goes well, and it's certainly the null hypothesis, the idea would be we would take control in the first part of '15.

Benjamin Swinburne - Morgan Stanley, Research Division

Great. So that's what you -- one more big-picture question shifting over to the U.S. before we get into some of the more detail drivers. There's been a lot of consternation in this television season about viewership and ratings, and Discovery has been one of the few with sort of consistent ratings growth with the overall ecosystem. If you look at Nielsen numbers, it appears to be flat to eroding. What do you make of that? I mean, obviously, you guys are winning right now so you're in a better position than most. But what do you think the overall consumer trend is in television? And how do you think about online options impacting those trends?

Andrew C. Warren

Look, we had some great success. I mean, we've -- our ratings were up across our portfolio in the U.S. 8% for the year, 17% for the fourth quarter alone. So we have had some success. But look, we believe in the content model. And so we have put a lot of money behind content. As some of you may have heard, we've put -- invested additional $200 million into our content across our 13 channels in 2012, relative to '11. So we believe that great content can win the game. For us, in the U.S., we're not broad entertainment. I mean, we do have very niche and very focused demographic and affinity groups that really are attracted to our channels. And so that model has worked well for us. You look at -- in 2012, we have the best year ever for Science, for Animal Planet, for ID, for Destination America, I mean -- so we've, across the board, we've had some real great success in investing in niche-affiliate -- affinity group content, and it's worked out well for us.

Benjamin Swinburne - Morgan Stanley, Research Division

Great. Let's dive in the international business, which is one big differentiators for Discovery as a stock and investment opportunity for the market. So in the fourth quarter, you guys grew advertising 18%, affiliate 12%, but again, that's been kind of unique in the market. A lot of your peers have had much lower international results. What's driving -- and this is sort of the pre-SBS piece, so this is your core international business, what's driving that success? Even in Europe where markets are much choppier from a macro perspective?

Andrew C. Warren

Arguably, no one has a better and more well-established international platform than Discovery does. I mean, look, we have 150 channels reaching 1.3 billion subscribers. We have it -- it goes back to my comment about our Board taking a very long view and management taking a long view. We were investing in a lot of these -- in these markets, with people and content and distribution long before others were. So we do have a leg up on that. So we have in -- in some of the big markets, we have up to 11 channels. So we have a meaningful position, and as like in the U.S., 10, 15 years ago, where there's a migration away from broadcast into pay-TV, we're seeing that from these markets as well. So when you have a leading position, and local feet on the ground; we have people in over 50 countries, representing us on ad sales and affiliate and content. And so when you have that kind of depth and breadth of people and distribution, it just gives you a much bigger amount of influence as these market dynamics change like they have in the U.S.

Benjamin Swinburne - Morgan Stanley, Research Division

So it's really not just ratings-driven, it's really infrastructure and the whole...

Andrew C. Warren

It is, Ben. I mean, look, we've had good success ratings-wise, internationally as well. I mean, there's a bit of a, call it, 6-month lag maybe in the ratings curve between the U.S. and international, because so much of that content is re-purposed. We own most of the global rights for our content. So as things work here, especially for Discovery and Science and ID and others, we're able to re-purpose that content. So that ratings trend often lacks, but we're having some good rating success there as well, but I do think the infrastructure is what's really whole and unique about Discovery.

Benjamin Swinburne - Morgan Stanley, Research Division

Maybe you can take us through, if we just think about Europe, Asia, Latin America, what are the drivers in each of those businesses? What's -- what do the relative growth rates look like and profitability levels to the extent you can talk about?

Andrew C. Warren

We talk a lot about Latin America, and it's generally is a big growth driver. When you look at our sub growth last year in Brazil, it's over 30%, it was over 20% in Mexico and Chile, but it's not just Latin America. We've had 20% sub growth in Poland, in Russia and India. So we're getting some really good growth across a lot of our platforms. So the growth rates kind of vary, but we're seeing this kind of solid, consistent double-digit growth in our sub base, which is certainly leading to a top line growth as well.

Benjamin Swinburne - Morgan Stanley, Research Division

Yes, you're right, Latin America is sort of the popular go-to-market right now in the industry. What about Asia and particularly in India, and some of those markets, what are your guys doing and seeing in those markets?

Andrew C. Warren

Asia is a very important business for us. We have 8 channels in 35 countries, reaching over 360 million subscribers. And there's a lot we're doing there, I mean we're launching channels in Korea, we're launching ad-supported feeds in Malaysia, in Indonesia, in the Philippines. So we are -- we're broadening our offering. We have a big initiative right now to take TLC across the region like we did particularly in Europe. Discovery Kids is a huge success for us in Latin America, and we're taking that to Asia. And that's had some real success for us early on. So it is an important region for us, I mean, ironically, something that made me surprised, The interview that Oprah did with Lance Armstrong was actually the #1, other than sports, the #1 one pay-TV program in the history of Australia. So that kind of content that we were able to simulcast to be broadcast in other regions gives us a huge opportunity. As regard to India, it's -- well India is an interesting game for us. I mean, we clearly have a big presence there, we're the #1 nonfiction media company in India. We also have 8 feeds there, reaching 160 million households, but there are 30,000 cable operators there. So the good news is India just recently -- the Indian government mandated that cable operators migrate from analog to digital, that will dramatically help.

Benjamin Swinburne - Morgan Stanley, Research Division

Against piracy.

Andrew C. Warren

It really will. And so in large markets where that migration is kind of already happening, we're seeing traction to digital. Not surprisingly, we're seeing real sub growth, vis-a-vis, of the lack of piracy. So we're very bullish on India. And believe very much -- we've had double-digit growth there, we think that migration to digital, given our #1 nonfiction position today, could be a really advantage for us.

Benjamin Swinburne - Morgan Stanley, Research Division

Let's talk about on the expense side, internationally. Really one of the other pieces of the Discovery story for investors is the ability to re-purpose U.S. content. Is that changing at all as you guys get just larger internationally, launch all these new markets, make acquisitions, the amount of local-originated programming, amount of money you spend overseas going up?

Andrew C. Warren

It absolutely is. We still look for about 50% then of our international content to be re-purposed to U.S. content. So again it's so important that we understand and own those global rights. So we absolutely are putting more and more money behind international content. When you have the kind of local presence that we have in these markets, as I mentioned, 50 countries, we have actually feet on the ground. We are more and more developing local content. In some cases, that local content is being migrated to the United States. So the fact that we can cross-pollinate content now in a very limited position, but yet, that's a growing opportunity for us. But you will see us and hear us talk more and more about where we're seeing double-digit top line growth and double-digit subscriber growth, we'll continue to put more money behind content.

Benjamin Swinburne - Morgan Stanley, Research Division

Can you talk a little bit about the TLC rollout? I know it's a couple of years old now when you started that initiative and also ID. How have those benefited the sort of revenue trajectory of the company? And sort of what's the next big move for you guys internationally?

Andrew C. Warren

Discovery has been a huge success for us. I mean, it's been -- it's in over 150 countries today. It's -- when you look at -- right now, we have 5 channels that have over 100 -- in over 100 countries and territories. Discovery, TLC, Animal Planet, Science and ID. So when you look at where the growth opportunity is though, while ID is in over 100 countries and territories, it only reaches 60 million subscribers, relative to Discovery which reaches 300 million. TLC reaches only 150 million, as I said. So there's a huge opportunity to not only still grow our subscriber base despite the fact we're in a lot of these countries. But for us, clearly there's an opportunity with ID, to broaden that in a much bigger way. And right now, we have kind of #1 position with so many channels, it gives us an opportunity to really get a lot more traction.

Benjamin Swinburne - Morgan Stanley, Research Division

And how do you get that increased distribution? Is it just like the U.S. market, you go negotiate for it, like use the scale you have?

Andrew C. Warren

Yes. Look, it actually really helps. I mean like in Brazil, for example, we have the #1 pay-TV channel and surprisingly, it's Discovery Kids. And so when you have that kind of #1 position, we have 3 of the top 10 channels in Brazil, it gives us an opportunity to leverage that to broaden our channel offering. But we already have 11 channels in Brazil, so our position there is already strong, but in a lot of these other countries, where maybe we only have 2 or 3 or 4 channels, we're able to leverage that position and the long-term relationship. A lot of those markets we've been there for literally 25 years. We were the first entrant in the market. So it gives us a lot of leg up in a lot of important relationships that we can lean upon to grow our offering.

Benjamin Swinburne - Morgan Stanley, Research Division

Can you talk a little about international margins? Your margin, I think when you went public, internationally, I think they were at high 20s, something like that.

Andrew C. Warren

That's right.

Benjamin Swinburne - Morgan Stanley, Research Division

They've gone up a lot. What's the outlook for margins? And how does the SBS deal sort of have impact that, if it has at all?

Andrew C. Warren

Well look, the -- it's a great question. I mean, SBS will dilute our international margins by about 300 basis points, once we close. So it is day 1 margin dilutive, even though it's very much EPS and free cash flow per share accretive. Well -- we still very much believe that we have an opportunity to grow international margins.

Benjamin Swinburne - Morgan Stanley, Research Division

From where they were in '12?

Andrew C. Warren

Correct.That's right. I mean in 2013, they will be diluted because of the SBS, but once you kind of reestablish the new baseline with SBS we do think there's an opportunity to meaningfully grow our international margins, largely because the infrastructure is in place, and we already have, as I said, feet on the ground in 50 countries, we already have the satellite infrastructure, the sales infrastructure, the affiliate infrastructure. So as more and more of our top line becomes ad-sales driven, and those are very high margin sales for us, we do expect in '14, '15, '16 to continue to see traction on the margin line internationally.

Benjamin Swinburne - Morgan Stanley, Research Division

And that 300 basis points is before any cost synergies that you guys might be able to extract? Is that...

Andrew C. Warren

That's right. That's right. But those will come over time, it won't be day 1, but we have a good line of sight towards meaningful synergies in both the cost, tax and revenue side, but a lot of those will really honestly more benefit '14.

Benjamin Swinburne - Morgan Stanley, Research Division

Right. Makes sense. Great. Let's shift over to domestic business. We were talking out in the hall a bit about the ad market surprising people to the upside, at least early this year. Any update on scatter trends from the call -- from the quarterly call you guys had a few weeks back? And how are you seeing the U.S. ad market right now?

Andrew C. Warren

Look, it's still robust for us. We called out, on the earnings call a couple weeks ago that we're still seeing solid 20-percent-plus scatter premium over upfront. We're seeing that today. And so we called out on the call that first quarter would be high single-digit growth in the U.S. We still believe that. Cancellations are kind of in the low end of the average for what we've seen historically, very much in line with the first quarter a year ago. But, look, it still is for us a robust market.

Benjamin Swinburne - Morgan Stanley, Research Division

Great. And looking out to the rest of this year, your ratings comparisons eased, and you have the Olympic issue that you'll lap -- issue last year, benefit this year. So I mean it feels like a pretty good trajectory as you move through 2013 on the domestic ad side right?

Andrew C. Warren

Look, it should be. Certainly, look, the third quarter comparison should be a little better, as you said with the Olympics, and we did have some soft ratings in the third quarter a year ago. But we still have the broadcast up front, we'll do it in the second quarter and that will hugely impact the fourth quarter trends. But right now, we feel good about the market and we feel good about our ratings trends, and so right now, it feels pretty good.

Benjamin Swinburne - Morgan Stanley, Research Division

Great. If we get past the sequestering process this week.

Andrew C. Warren

Yes. Right. Amen.

Benjamin Swinburne - Morgan Stanley, Research Division

The last time I say that word at this conference. Okay. And then let's shift over on the distribution side. So a big focus for the company right now is you're going through domestic distribution renewals. And you talked about -- a little about in the earnings call that we're in a period right now where we're seeing just really robust growth across the industry on the affiliate -- domestic affiliate fee side. How should investors think about Discovery's sort of pricing power, position and also strategy? What are you guys looking to get done as you go through these renewals, I think some of which started at the end of 2012?

Andrew C. Warren

Well our #1 focus is getting growth of the sub fee base and growing that consistently over time, and the deals that we did in 2012 accomplished that. But we're also very focused on continuing to broaden the distribution before emerging that. If you look at ID, for example, a few years ago it was in 55 million homes, now it's in over 80 million. And so across the board, we're looking at not only getting solidified growth of our sub fee base, but for us, the asset value creation, the increased ad sales and the increased long-term affiliate growth over our emerging net platform is incredibly important for us. And again, it's that long view we think about shareholder return and growth. But -- look, for 2013, there won't be a huge amount of increase relative to '12, quite frankly, because in '12, as we've said, we've only had less than 20% of our subs come up to contract, and would have to be recontracted. When only 20% comes up, it's not going to have a huge impact on the overall '13 growth rate. So expectations for '13 should be modest, relative to what they were in '12.

Benjamin Swinburne - Morgan Stanley, Research Division

Right.

Andrew C. Warren

But again, we like the hand we have to play, we like the fact that we're roughly 10% of the pay-TV audience but only 4%, 5% of the pay-TV sub base. But it's competitive, we're going to balance the sub growth with broadening our distribution.

Benjamin Swinburne - Morgan Stanley, Research Division

I'm sure no one negotiation is easy, but when you go into these negotiations, how are you thinking about greater distribution on the emerging net? I mean getting ID from a distributor, for example, would be, I assume, like a huge opportunity for the company. I don't know if it's easier to digest for the pay-TV operator than a fee increase, but at the end of the day, I'd be curious how you think about that?

Andrew C. Warren

Look, it's very hard. Once you get to 60 million subs, it's very hard to get to that next 70 million, 80 million. And we've been able to do that. I mean, Bill Goodwyn and team are the best at this. And a lot of it is the constructive win-win relationships that we have with our affiliates. We've never gone dark. And so we certainly fight for and get the best deals that we can, but affiliate growth -- sub fee growth is an important part of the equation, and clearly, if you think about our ability to grow Destination America, it's in 60 million homes today, yet the offering there and the ad sales traction we have is tremendous. So we're very focused on getting that channel, if we can, to 80 million homes over time, like we did with ID, like we did with OWN. So it is absolutely a balanced bin, but our #1 priority is sub rate growth, but asset value creation and that top line potential of growing our emerging net we have is tremendous as well.

Benjamin Swinburne - Morgan Stanley, Research Division

Is ID the single -- if you have to sort of boil down to one top opportunity to drive EBITDA in the U.S. business, is ID that asset for you guys right now?

Andrew C. Warren

Look, I think the answer is clearly yes.

Benjamin Swinburne - Morgan Stanley, Research Division

Over the long term?

Andrew C. Warren

I think it is. I mean clearly, if you look at -- it's the top 20 channel today, yet its pricing is way below that kind of heft. So I think the combination of where we are now with the affiliate growth and catching up there, clearly the ability to grow CPM there relative to breadth of that channel is a big opportunity for us. But look -- I'll talk about Destination America, to a degree that we get real traction on that, it couldn't be more ad sales and affiliate-friendly than what that channel is. If you've seen it, you kind of want to go the town hall and go to church afterwards. I mean it's a fabulous channel around celebrating America and celebrating kind of what we are. And so our traction there has been real. But for us, I'm still also very bullish on our ability to grow Discovery and TLC. Eileen O'Neill is one of the best programmers in the space, bar none. And we really have that group figured out, and she now has us targeted in on the right demographic, and you can see the traction we're getting. And just last Friday was actually the biggest Friday night Discovery has ever had in its 25-year history with Gold Rush Live and Yukon Men. And so they have launched Amish Mafia and Moonshiners has been a huge success. So we're really broadening the offering, and more and more we're having sophomore and junior and even senior-year seasons, it's a big hit. So you'll see growth out of those mature channels as well.

Benjamin Swinburne - Morgan Stanley, Research Division

Great. Let's shift over onto the digital side of the equation. And over the last 3 to 4 years, at this conference, we've probably had the mood swing from whether a cord cutting is happening or not, and where network fits in, who will hit it from later today, is it the ecosystem that -- where is Discovery today on thinking about monetizing your library or even your more current content online? And how are you thinking about TV Everywhere rights as they relate to your core distribution partners?

Andrew C. Warren

Yes. The TV Everywhere right is a big discussion, I know, but the challenge is there's no commonality today amongst the affiliate groups. Whether it'd be about usage, about windowing, about what the value is, the discussions are good and robust, I think the fact that Nielsen last week came out and said they're going to start in the first quarter of '14, start to measure tablet usage and non-cable TV viewing on Internet. I think it's very helpful, and that will be a good way for us to help monetize some of that TV Everywhere usage. But we've been hesitant to give away those rights because again, just not -- we're not well aligned yet on what the value is. To us, we've done deals with Netflix, we've done deals with Amazon, we have a third year option for Netflix this year. And while we're very happy with how those have done, for us it's so important to make sure that you preserve the ecosystem. And we've been very careful about windowing those rights. And so we've -- everything we've done with Netflix and Amazon has been 18-month content or older, to us, that's incredibly important delineation to make sure that we carve out the windows. But look, we have a library of over 100,000 hours of content. And so we've used some of that with the deals we've done. The good news we get a lot of calls from a lot of people wanting to use our content. And so we're just very judicious about how we're going to use it, when we're going to use it, and make sure the value creation is there.

Benjamin Swinburne - Morgan Stanley, Research Division

Not to name names -- not to ask you to name names, but are you comfortable with how the industry is approaching it? Because as you mentioned, every media company has a little bit of a different take on how aggressive the window should be? How close to airing? How much content? Do you feel like the industry is in a good place? Or are you concerned about it?

Andrew C. Warren

Yes. I would say, Ben, I'm a little concerned in that I'm not sure everyone is taking the long view on this. Right? I mean we try to be, as I said, very careful about how we window it, how we curve out our rights to make sure that we don't overly impede current deals we have or that we don't disrupt the ecosystem of especially of the linear platforms. But yes, I think everyone understands that, but I think we've been told by all of the affiliate teams that we've been a good player in that game and that when we go out for renewals in our affiliate deals, what the comments we hear is we've been very responsible and we make sure that we don't utilize rights or windows in a way that's really hurting them. So I think we've been a really good character in this, and I think we really have a long view on it and I hope everyone else does as well, and I think in some cases, they don't.

Benjamin Swinburne - Morgan Stanley, Research Division

Interesting, thank you. Same question on domestic when I asked you on international about margins. You have envious margins in the domestic business compared to your peers, where do you see those going over the longer term? How do you manage the business around margin targets? You mentioned free cash flow, I think, is the most important lever.

Andrew C. Warren

Yes. Yes. Well look -- the -- in 2013, you will see domestic margin compression a little bit because of the content-end worth that is going to be flowing to the P&L. We have dramatically increased our content cash spend in '11 and '12 with tremendous payback based on our ratings, as I said. But if you look at what we've highlighted on our earnings call a couple weeks ago, was we would have kind of low- to mid-teen content-end worth growth in '13. And so that will compress margins. But despite that, I absolutely see our ability to still have traction even with U.S. margins over time. We do look for at least 60% to 70% margin flow-through on incremental revenues domestically. Obviously, our infrastructure and team is in place, so it really is about variable cost, and the biggest one we have is content spend. And so you'll definitely see a slower growth of content spend in '13 than '12, [indiscernible] is going to be up.

Benjamin Swinburne - Morgan Stanley, Research Division

On the cash side.

Andrew C. Warren

On the cash side. Largely because -- look, in '11 and '12, we were investing very much in ID, in Destination America, in what we believe to be the right number of original hours of content programming. We're largely there across all of those kind of key initiatives. We have the right original hours, we have the right kind of ID profile, today, of content. So really now, it's about just investing in core content that we believe really has global potential. So while we'll still increase the amount of content spend, it won't be nearly to the extent that we did in '12.

Benjamin Swinburne - Morgan Stanley, Research Division

Great. Let's shift over to the JV network. You mentioned the Lance interview in Australia, and I can only imagine the reaction that viewers had to that. But update us on OWN. It was -- that's another one where it's been a sort of a roller coaster ride, but it seems like you really turned the corner on that network.

Andrew C. Warren

We actually have been. I feel very good about OWN. I mean, the engagement of Oprah on this is tremendous. I mean, she really -- this is her one-content play, all of her voice and her messaging all comes through this channel now. And she's very committed to it. So we have all the affiliate deals done except for one, the affiliate sub fee started this past January, which dramatically changes the cash profile of the channel. Ratings were up over 30% in 2012, they continue to be up double digits versus last year. So look, we said a year ago, when most people thought of this as being a liability versus an asset, we said a year ago that 2012 funding would be less than '11, our funding to OWN, and we said that second half of '13 we'd be cash flow neutral. We absolutely accomplished that goal of '12 funding being less, and we feel very good about second half '13 funding being, at worst, 0. And so I feel great about it and I think investors really see it now as being a definitive asset for us versus a liability they thought a year ago.

Benjamin Swinburne - Morgan Stanley, Research Division

And how should we think about OWN's long-term opportunity given the demo you're targeting and where the economics are today versus where they could go? Could this be a top 10, 20 cable network over the long term?

Andrew C. Warren

Look, to me, no question, it could be at top 20. I mean you just can't underestimate the following that Oprah has. I mean, she has the #1, I think, other than President Obama, the #1 Facebook following on the planet. And so -- I mean, her brand and her audience and the affinity they have with here is breathtaking. And so when she really hits the right Oprah-esque quality, and sometimes it's not just her, I mean when you look at what we're doing with other content outside of her, we -- really we're getting the kind of traction now and the kind of rating that's beyond just Oprah interviews. And so I feel great about it being a top-20 channel down the road, and traction in the last 14 months have been undeniable.

Benjamin Swinburne - Morgan Stanley, Research Division

Yes. Great. Let me ask one more and then we'll open it up to the audience for any questions. On, which is a business you used to be 100% owned in Kids, you've moved that into a JV. Talk to us about the Kids market as Hub plays in that market. You had a lot of growth last year, still a pretty small player, but how do you see the outlook for that network?

Andrew C. Warren

Well, that's an example of percents could be misleading, right? I mean while their percents are up, I think rating is up 38% last year, and that's great. It's a very competitive space. And look, we like very much the relationship we have with Hasbro, the JV has been very successful, and we're getting a lot of traction. But it's a very, very competitive space. So it will -- our long range plan for the hub is very profitable, and it will be some nice cash flows to Discovery and Hasbro over time. But the traction has been there, but the competition is just very real. But we believe very much in it, and we love the fact that we’re getting traction and sub fees, and more importantly, we're sitting -- we're seeing more and more ad sales migrating away from some of the bigger platforms and coming into Hub.

Benjamin Swinburne - Morgan Stanley, Research Division

Great. Let me see if we have any questions from the audience, and we have to wait for microphones to come around. So just humor us for a minute. There's one back, 2 over here on this side.

Unknown Analyst

Talk about [indiscernible] ID from expanding abroad sort of similar to what happened with Discovery, the core Discovery. Could you talk about how different the incremental margins are? Because obviously, it's a little bit hard to re-purpose ID and TLC content compared to a Discovery so can you talk about sort of the margin profile on ID and TLC?

Andrew C. Warren

Sure. Like -- it's very much varies by country, as you can imagine. I mean, in some cases, we just have a more well-established ad sales profile, and in some cases, the pay-TV market is just more mature. So when we launched TLC, for example, in Italy or Brazil, we really have had some very high margin success there. We are putting more money behind content, more localized content, but the margin is very mostly not by the channel as much as by the ad sales penetration in those markets, and the maturity of pay-TV in those markets. So for us, we're definitely seeing meaningful margin traction, but it's all about to what extent is our ad sales really migrating to pay-TV. They have in some of the mature markets, and when that happens, our margins really take off.

Benjamin Swinburne - Morgan Stanley, Research Division

Great. Thought we have one over here but maybe not. Got one in the front row here.

Unknown Analyst

For the content that you're after, could you give us what the landscape is like, how competitive it is? Do you commission programs to people who come to the idea? Then do you compete, like directly, with National Geographic for content and things like that? Would just like to get the overview, the future of the content for you.

Andrew C. Warren

Sure. As you can imagine, we have an extremely well-established and mature content pipeline. Because of who we are and the breadth of our offerings across our channels and the fact that we have the ability to re-purpose content across over 215 countries and territories, it's a very attractive place for people to come to and pitch ideas. Whether we fully commission depends on whether we think we can really utilize those global rights or not. In most cases, the decision is yes, so we will fully commission. As far as competing with Nat Geo or HISTORY, I mean, there's a little bit of that, but we're just so well established with the big players, and because no one can deliver the kind of global reach that we can, it's a huge asset. I mean if you're a producer of a unique concept, there's nothing like being able to come to us and we can say, "We can give you a global reach and a global audience that no one else can." And you look at, like the Lance interview, the fact that we can speak to that, not only we were able to simulcast or delay show that to over 100 countries and territories. But the fact we had the kind of success we have in Australia, those examples really resonate with producers. So the competition is not as much the struggle, as much as just selecting a huge amount of content opportunities and ideas. And that's where the content teams are the best at that.

Benjamin Swinburne - Morgan Stanley, Research Division

Can you talk a little about the free cash flow outlook for '13 and how you're thinking about allocating capital?

Andrew C. Warren

Yes. Look, it's the -- as you all have heard me say, free cash flow per share is my #1 metric. It's a metric that I think is the best as far as fully delivering long-term shareholder value. So you'll hear me talk about that a lot in these conferences and our earnings calls. 2013 free cash flow looks actually very good. I mean, not only we are going to be investing less growth on the content side, there'll -- additional growth but not as much as '12. But you heard me talk a bit about the 181 extension and Section 181, which allows us to fully deduct U.S. content costs within the year, was something that the Congress passed just recently and it was retro-ed at 2012. So that's over $100 million of cash benefit in '13, it will drive from that 181 extension. So the combination of that, plus continuing to really manage costs and think about productivity in a very real way, plus the fact that we're going to have less growth in our content spend, I feel very good about our free cash flow growth and particularly free cash flow per share in '13.

Benjamin Swinburne - Morgan Stanley, Research Division

Last year, I think the cash spend was higher than you guys expected at the beginning of the year. It doesn't sound like you feel like there's a real risk to the number this year. Can you sort of walk us through why that is?

Andrew C. Warren

Well look, we will absolutely invest in opportunities. I mean, to us, the lens that we look we look through is does the team really have a clear view of who the audience is, do they really have a very clear, defined profile? Do we really see a monetization opportunity? If we're going to put more money behind a brand or a channel, do we think we can really monetize it? And last to the answer was clearly yes. And with 17% ratings growth in the fourth quarter, 8% for the year, we clearly have success in monetizing that. Look, I think the opportunity this year, while very real, to invest more, as I said though, we've largely now taken our channels to the level of original content that we want to have. We really now know, in most of these -- in most of our channels, maybe other than DA, which we're still very much tweaking the model because we just launched it last May. Most of our channels really know the audience and so we can really target our spend in a much more specific way, and that really allows you to have less waste, if you will, and less unsuccessful money spent. The more returning series we have, which we have kind a record number of returning series on Discovery and ID and TLC, that really allows you to kind of maximize the value of your spend. So I think our line of sight to success is much clearer now than it's been any time before.

Benjamin Swinburne - Morgan Stanley, Research Division

Great. Andy, thank you very much. Thanks, everyone, for being here. Thank you.

Andrew C. Warren

Thank you. Appreciate it.

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