(FORTUNE Magazine) – No one could ever accuse anybody at TiVo of understatement. "TiVo is the first and only post-Internet Big Idea," CEO Mike Ramsay unabashedly proclaimed over dinner at a popular Palo Alto restaurant last month. He was referring, of course, to his company's product, a curious contraption known as "smart TV," as oxymoronic as that may sound. "We're transforming the future of entertainment," Ramsay continued. "People who use it say it changes their world." As if on cue, the waiter materialized to deliver food to our table. "Hey, are you guys from TiVo?" he asked. "My girlfriend got me one for Christmas, and, man, I looove it!" His timing was so impeccable that I became suspicious, so much so that I visited him a couple of days later just to make sure he wasn't being paid for his testimonial. He said that he wasn't on the company's payroll, that he had wanted TiVo after hearing about it from friends and seeing a demo. "TiVo has totally changed the quality of the TV I'm watching," he gushed. "It's got everything. The future is wide open for this technology."

So what is it about this thing that makes perfectly normal human beings sound as if they were hawking Ginzu steak knives on late-night TV? TiVo calls its product personalized video recording (PVR), a technology and service that enables viewers to watch what they want, when they want, not to mention skip the commercials. Ever since TiVo hit the market a year and half ago, consumer feedback has been overwhelmingly positive. The response from TV and ad execs has been more wary. If enough people were to use PVRs, it would upend the way network programming and advertising works today. In February 2000, Forrester Research analyst Josh Bernoff penned a report on PVRs titled "The End of TV (As We Know It)." Six months later, writer Michael Lewis added to the hype with a breathless cover story for the New York Times Magazine. He declared that PVRs would lead to the end of the mass market. The photo on the cover was of an exploding Kellogg's Corn Flakes box.

Today, however, TiVo finds itself in a quandary. On one hand, the Alviso, Calif., company is now the leader in PVRs, having won its highly publicized battle with rival ReplayTV, which stopped selling to the consumer market last fall. TiVo boasts a high-profile board of directors and has expanded its impressive list of strategic partners and institutional investors. On the other hand, Wall Street refuses to share the enthusiasm. After reaching a high of $72 three months following the company's September 1999 IPO, the stock came crashing down by 94% and now trades at $4 a share. Moreover, TiVo probably won't turn a profit for at least three more years. And although TiVo boasts 153,000 subscribers, that falls far below previous expectations. Analysts predicted in late 1999 that TiVo would have more than 300,000 subscribers within a year. As if all that weren't bad enough, Bill Gates is ready to pounce. This month Microsoft will enter the market when it rolls out its UltimateTV product. Still, by far the biggest obstacle facing TiVo is that most people don't know TiVo from Titus, the Roman emperor. Ramsay may want to lead a television revolution, but you can't storm the Bastille if no one knows where it is. Oh, and in case you're wondering, the mass market still exists.

Ramsay, 51, and TiVo's co-founder and CTO, Jim Barton, 42, have tinkered with smart TV before. Both were involved in Silicon Graphics' failed 1994 venture with Time Warner to test interactive TV in Orlando, Fla. Wanting a change, the two left SGI to look for something new to work on. In 1997 they went over a few possibilities, among them a company that specialized in networking home appliances. It had the soporific moniker Teleworld and was the genesis of TiVo. After realizing it was an idea whose time had not yet come, the duo decided to focus on the most popular item in any home, the television. TiVo wouldn't merely be a souped up VCR; it would be a service too. Yes, viewers would be able to digitally record shows and watch them at any time. They would also be able to pause and control live feeds of TV, run instant replays at will, and basically program their own personal network, all thanks to a black box sitting on top of the TV set. TiVo would subsidize and outsource the manufacturing of the hardware and charge a monthly fee. Most importantly, TiVo would be really, really simple to use. (For more on how TiVo works, see box.)

TiVo's courtship of investors over the next couple of years was impressive. By venture capital standards, it wasn't exactly a big draw. The company had an expensive business model, was creating a new consumer electronics category, was subsidizing hardware, was service- and subscription-oriented, and wouldn't be profitable for years. But Ramsay and Barton's vision for customized television proved too strong to resist. TiVo's first VC backers were heavy-hitters: New Enterprise Associates' Stewart Alsop (who is also a columnist for FORTUNE) and Redpoint Ventures' Geoff Yang.

Realizing the risk of taking on the all-powerful television industry, Ramsay hired Stacy Jolna, an Emmy-winning programming exec, as chief programming officer. His job: to reassure networks and advertisers and bring them into the fold. Not all were receptive. Early on, Jolna and Ramsay met with USA Networks chair Barry Diller. "He was impressed with the product," recalls Jolna. "But when asked to invest, he had a broad grin on his face and said, 'Let me see if I understand this. All the other companies are investing in you so they can preside over their own demise?' " Other broadcasters sensed that it was better to work with TiVo than against it. "The big mistake with broadcasters 20 years ago was that they didn't understand cable," says John Hendricks, CEO of the Discovery Communications networks. "Instead of jumping in and working together, they stayed on the sidelines. It would be a mistake to do the same with TiVo today."

About a month after the IPO, TiVo rolled out its service nationally. The people who bought at first were typical early adopters--young, male, tech-savvy. They loved it. "I was at Apple during the early days of the Mac," says Silicon Valley guru and TiVo board member Randy Komisar. "My buddies were part of Palm, and I watched as the handheld took off. But I have never seen a product that was so well received as this. Never."

So far, so good. The real challenge was still to come. In order for TiVo to revolutionize television, lots of people needed to buy it. And in order for them to buy it, they needed to know what it was. But TiVo blew some $50 million last year on a baffling national campaign that failed to explain what the device did. "Here's a box that has benefits that people don't understand," says Forrester's Bernoff. "This is a very hard product to sell by showing it on television." In one infamous TiVo commercial, a couple of angry men, sick and tired of having programming shoved down their throats, toss a network executive out the window. CBS refused to air it.

TiVo execs claim that last year's ad blitz was part of a master plan. "We spent the year creating brand awareness," explains marketing vice president Brodie Keast. This year TiVo will concentrate on infomercials and more training for salesmen in retail outlets. "Now we need to focus on educating consumers," says Keast. Bernoff thinks that the company should encourage viral marketing, taking advantage of its devoted users. "They [TiVo lovers] should have TiVo parties, like Tupperware parties. The most effective marketing is when you go to someone's house and they show TiVo to you." TiVo will have to persuade prospective customers to pay $399 for a PVR, plus a $9.95 monthly fee. But consumer electronics gadgets don't usually appeal to the mass market until they cost less than $300, and TiVo has no plans to lower its prices anytime soon.

The other big problem facing TiVo is its balance sheet. Nearly all of last year's paltry $3.7 million in revenues came from subscriptions. Getting new customers isn't cheap--the current subscriber acquisition cost (SAC) is over $1,000. CFO Dave Courtney says that was mostly due to high marketing expenses (translation: those brilliant commercials) and that the SAC will drop next year to about $550 per customer. Maybe, but again this year the number of new subscriptions will fall short of earlier forecasts. TiVo predicts it will add about 200,000 customers in 2001; original expectations were for 350,000.

As for earnings--don't even think about it. Last year's net loss per share was $5.55. Courtney will say only that TiVo will be profitable "in a few years," adding that lead times for profits and cash flows are much longer in the television industry than in high tech. "I'm surprised at how we're misunderstood. There's still this belief that we're producing boxes or that we're an Internet company." But as TiVo's $191 million market cap shows, Wall Street doesn't have much patience these days, and investors are putting a premium on results--now.

The competitive landscape is about to shift. TiVo's main rival for the past two years, ReplayTV, was never able to secure the financing that TiVo enjoyed. Replay's original business model was expensive; the company manufactured and sold PVR devices without charging a subscription fee. In October, Replay announced that it would alter its model and license its technology instead, and in January the company was sold to hardware maker SonicBlue for $120 million.

But TiVo won't be the main PVR provider for very much longer. Microsoft's UltimateTV, bundled with Hughes Electronics' DirecTV satellite service, is hitting stores any day now. Two years ago Microsoft's beleaguered WebTV service, which offers Internet access through TV sets, began offering a PVR with Echostar's DISH player. With virtually no marketing at all, it sold 200,000 units. Microsoft discovered that most users were not surfing the Web, but were using the recording device instead. So WebTV President Bruce Leak decided to rebrand. Priced the same as TiVo, UltimateTV will have PVR capabilities, but the key difference is that it will have two tuners, so viewers will be able to record two programs at once. (TiVo says it will make two tuners available for its DirecTV bundle this summer.) Web access hasn't disappeared; it's just no longer the main focus.

Microsoft's biggest advantage, obviously, is deep pockets. The company's ad campaign for UltimateTV isn't any clearer about PVRs than TiVo's. But Microsoft's marketing typically depends on repetition and volume. If those make a difference--and they often do--then there's a real chance the company will prevail.

TiVo executives are concerned about, but not alarmed by, Microsoft's entry, believing that the software giant will help raise awareness of PVRs. "There are more households with televisions than there are with running water," says Keast. "There's a place for both companies.'' CEO Ramsay is a tad more dismissive about Microsoft's long-term viability in television. "Microsoft is to TV what Jesse Ventura is to politics," he sniffs.

Meanwhile, TiVo isn't sitting still. In January the company announced a shift in strategy. Currently, nearly all of TiVo's sales are from subscription fees. Stacy Jolna's mission is to increase other streams of revenue by developing partnerships with networks and advertisers. He's offering a menu of choices, like the Network Showcase, which lets programmers bundle their shows into special previews. For example, NBC packages together all its late-night offerings. Other options for partners include sponsoring segments of TiVolution Magazine, an interactive program that gives viewers information about upcoming shows. The idea is that someday advertisers will be able to aim ads at small groups with specific interests, on the basis of TiVo subscribers' viewing habits. So far, the response has been positive. Preliminary partners include NBC, HBO, Starcom Media, and the Omnicom Group. Still, trying to please networks, advertisers, and viewers is a tough balancing act. Not everyone thinks TiVo should even try. "Partnering is not really important for them," says Bernoff. "It's the networks' problem that these devices make it easy to skip advertising."

So, then, if TiVo has smart people, a great technology, consumers who love it, and a long-term vision of how the world will change, what doesn't it have? Money. This is where AOL Time Warner (parent of FORTUNE's publisher) comes in. Last summer AOL announced a $200 million investment in TiVo, as well as plans to combine its TV-based Internet service, AOLTV, with a TiVo box. In January, AOL Time Warner released another $43.5 million to TiVo for working capital and struck a new strategic marketing partnership. AOL now owns 13% of the company. That could increase to 30%, since it holds warrants and convertible preferred stock that haven't been exercised or converted yet.

Many people wonder whether TiVo can continue as an independent company for very much longer. "The TiVo interface and brand name and technology are hugely valuable long-term. This company will have an enormous influence on how consumers interact with television," says Forrester's Bernoff. But with the stock price not reflecting TiVo's potential, and with Microsoft closing in, TiVo makes a very attractive acquisition candidate. "Is TiVo worth more than $4 a share to AOL? Yeah. Viacom? Probably. Paul Allen? Sure. Somebody needs to wake up and pay attention. The value is in its long-term power." AOL CEO Barry Schuler says there are no immediate plans to acquire TiVo. But he doesn't rule out the possibility. "If they came to us and said that they felt they had better chances with making their product happen as a part of AOL, it's something we would think about."

The folks at TiVo have no interest in being part of a larger company. Ramsay maintains that his mission is long-term, pointing out that even PCs took a long time to catch on. But can TiVo go it alone? When I ask Ramsay about a possible acquisition, he becomes slightly prickly: "We didn't create this company to sell it," he snaps. "TiVo is revolutionary." Maybe so, but even revolutionaries need help from time to time.

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