(FORTUNE Magazine) – FIVE MILLION PEOPLE WATCH HAPPY Tree Friends every week--about the same number that tune in to Dr. Phil. Its mailing list boasts 800,000 subscribers, circulation that would thrill any magazine or newspaper publisher. Happy Tree Friends T-shirts, dolls, and pins sell at trendy teen retailer Hot Topic; DVD compilations sell at Blockbuster and Amazon.com; and episodes air on MTV International. But Happy Tree Friends (www.happytreefriends.com) isn't produced by a conventional network, studio, or publisher. It's a crude, funny, animated Internet series, and its creators are betting it could be the next South Park. "This is a real business, built without broadcast time,'' says John Evershed, chief executive of Mondo Media, which produces it. "Our licensing agent gets more inquiries about Happy Tree Friends than any other property, and he handles the Beatles and Madonna."

The idea that there is a market for Internet movies and series was laughable five years ago, when the post-crash junk heap was littered with entertainment websites like Steven Spielberg's Pop.com and Digital Entertainment Network. But Evershed survived, and now he and a handful of others want to show they were right--if too early.

The rebound in online advertising helps. Amex, Coca-Cola, Hewlett-Packard, Warner Bros., and others buy ads on AtomFilms.com and iFilm.com, which show short films. Both nearly failed five years ago but say they are profitable now. "We've sold out ad space almost every month out of the last 24,'' says AtomFilms CEO Mika Salmi, who founded the company. "Our CPM's (the cost of reaching a million viewers) are approaching network TV's.'' The growing popularity of high-speed Internet connections is also aiding digital Hollywood's recovery.

The online entertainment players are also building more durable businesses this time around. JibJab Media is famous for the cartoon "This Land," which featured President Bush and John Kerry slinging insults to the tune of the Woody Guthrie song and registered a staggering 80 million page views. But brothers Gregg and Evan Spiridellis, who own the company, also make online and broadcast animation for the likes of Kraft Foods, Revlon, and Disney. iFilm.com has added studio film trailers, entertainment news, and videogame clips to attract Hollywood advertisers.

Despite their promising starts or restarts, no one is crowing about dot-com-era riches. iFilm turned its first profit last year. Evershed says Happy Tree Friends breaks even, with revenues in the low single millions, and should turn a profit next year. Gregg Spiridellis says he pays the rent but isn't rich. "You need enormous scale and broad appeal to make this work," he says.

That's one reason he and his peers have begun to embrace their conventional-media cousins. The sequel to "This Land," "Good to Be in DC!," debuted in October on Jay Leno's show; Yahoo has licensed the next two JibJab films, guaranteeing millions of page views. Evershed wants a regular MTV or MTV2 slot for Happy Tree Friends. AtomFilms has explored starting a cable channel. iFilm has wireless-content deals and is preparing DVD compilations.

But the new living-room media centers, which promise to merge TV and computer content, will most likely push the digital-entertainment community into the mainstream. "JibJab will license content to Atomfilms, which will license to TiVo or Microsoft to connect to a TV,'' says Josh Green, a media analyst at Jupiter Research. From a producer to a distributor and then a screen--that sounds a lot like classic Hollywood. -- Evelyn Nussenbaum