Video-on-demand pioneer tunes out amid shakeout. (Media & Technology).

A moment of silence, please, for Diva Systems Corp., a pioneer in video on demand. The Redwood City company filed for bankruptcy protection the other week, just as the VOD business is finally taking off.

Cable-television operators are expected to treble VOD service to 9 million households this year, with that number doubling by the end of 2003, Forrester Research analyst Josh Bernoff says.

But Diva couldn't hang on. In a six-year period, the company incurred net losses of $500 million while collecting just $39 million in revenue.

Gemstar-TV Guide International Inc. agreed to acquire most of Diva's assets for about $40 million if the U.S. Bankruptcy Court approves. This prepackaged bankruptcy denotes winners and losers in the consolidating cable-TV industry. Middlemen appear doomed to fail unless they have a lock on coveted programs or patents.

Diva had a nifty product but couldn't compel cable-TV operators to buy the service, much less on its desired terms. After sampling Diva, big cable operators often bypassed the company to build their own VOD services, dealing directly with computer manufacturers and Hollywood programmers.

Gold in the ashes

There is some irony in the fact that Gemstar, another middleman, sees gold in Diva's ashes. Gemstar intends to use Diva's technology to add full-range motion to its on-screen program guides, a business Gemstar dominates with an arsenal of patents.

Diva looked good on paper and the TV screen. It had a proud lineage dating back to Sarnoff Corp., formerly RCA Labs, which invented color television. Diva was formed in 1995 when it acquired certain rights to the Sarnoff video server, a processing computer capable of storing hundreds of movie titles.

Using its proprietary hardware from end to end, Diva installed the first commercial VOD service for a cable-TV system in 1997. The following year, Diva raised $250 million from a bond sale--more than double its initial goal.

With no interest payments due until 2003, Diva had five years to exploit its "first mover" advantage. Yet by the time of its bankruptcy filing, Diva had a scant 15 percent of the VOD market, according to Forrester's Bernoff.

Diva had no means of swaying the cable-TV operators to adopt its VOD service, much less its business plan. It initially wanted to retain ownership of its proprietary equipment, and proposed splitting VOD revenues with the local cable operator on an almost equal basis.

Fat chance. Few cable operators wanted an outside company to build a business on their turf. By 1999, Diva was meekly selling its equipment and service a la carte.

In 2000, it bowed to the realization that big cable-TV companies would go directly to Hollywood to negotiate for movies and other video programming, reducing Diva's role as a packager of content.

With its sails trimmed, Diva said it would look for other business opportunities, including the interactive program guide--the category dominated by Gemstar-TV Guide.

Not welcome

Diva unveiled its interactive program guide at a cable trade show in Los Angeles in December 1999. TV Guide Interactive responded by ejecting a Diva demonstrator from its booth. In mid-2000, Diva acknowledged that Gemstar might sue, while denying that it had infringed on Gemstar's intellectual property.

Diva's interactive program guide relied on streaming the video signal in real time to a viewer's set-top box, unlike the on-screen guides that download information on an hourly or overnight basis.

Although Diva tested its program guide in several markets, it retreated last June, saying it would cease further development efforts in IPG technology. By then, Diva's cash had dwindled to $33 million.

No Gemstar lawsuit materialized. Evidently Gemstar coveted some of Diva's patents, because it now says Diva's server-based technology will speed introduction of full-motion advertising and movie trailers on Gemstar's interactive program guides.

Gemstar insists that it won't pursue Diva's video-on-demand business. That's a relief to investors, who have seen their shares decline 65 percent this year on uncertainty about pending patent lawsuits and the outlook for advertising.

Gemstar says it will issue stock for the Diva assets. Meanwhile, the Pasadena company continues to buy back its own depressed shares on the open market. As a result, the Diva transaction isn't expected to dilute existing shareholders, Gemstar co-president and chief operating officer Jeff Shell says.

Before reaching its agreement to acquire the Diva assets, Gemstar consulted with "a number of cable operators" about its intentions, Shell says, and it will support the existing Diva service until cable operators find alternatives.