Can Liberate cash in on Microsoft's set-top stumble?

The negotiations are a slap in the face for Microsoft, whose own AT&T software trials have been repeatedly delayed.

Executives from AT&T and Liberate have been meeting regularly to discuss a potential deal that would put Liberate's interactive TV software into AT&T cable set-top boxes, according to high-level sources close to the situation. The talks come amid increasing reports of delays in Microsoft's development of similar software for AT&T.

Last week, Liberate engineer Jan Van Doorn visited AT&T to demonstrate how Liberate's software would work in AT&T set-top boxes, sources said. In addition, AT&T has been approaching Microsoft's third-party software developers, inquiring whether their software would also work with Liberate's technology.

AT&T declined to comment on specific negotiations with Liberate. "We're talking to a lot of companies a lot of the time," an AT&T representative said. "Our interactive TV platform has always been designed to be an open platform with multiple vendors."

Liberate declined to comment on any talks.

The news is the latest black eye for Microsoft's TV group, which has been marked by delays and management shakeups, as the company has struggled to find a market for its retail WebTV set-top boxes and Microsoft TV server software.

Many of the key Microsoft executives charged with managing the company's relationship with AT&T have left the group in the past year, one source said, explaining that many Microsoft employees were concerned about missed deadlines and contract renegotiations. "Things can't be good now," the source said.

One possible scenario has Liberate serving as either an alternative or secondary platform for AT&T's set-top boxes, sources said. Also possible: AT&T is using the negotiations as leverage to force Microsoft to finish the development and begin testing the boxes.

"AT&T needs some way to hedge its bets," said Richard Doherty, an industry analyst and president of The Envisioneering Group. He added that AT&T is likely getting nervous as major fall industry trade shows loom, where cable operators typically show off next year's products. If AT&T misses the shows, he said, it will likely have to wait an entire year to introduce the boxes.

"Despite the $5 billion investment (by Microsoft), AT&T can't take that chance," Doherty said.

Microsoft and AT&T have been jointly working on the interactive TV project since Microsoft's $5 billion investment in AT&T last year. But as the software delays continue, AT&T appears to be exploiting the nonexclusive nature of its relationship with Microsoft.

Although AT&T has held talks with Liberate in the past, the discussions have been stepped up as of late, one source said. "Since Microsoft is behind, AT&T is considering its alternatives, and that's the reason for the frequent activities" with Liberate, the source said.

While Microsoft faces delays in delivering its software for set-top boxes, Liberate is shipping its products in the United States and Europe. However, those familiar with Liberate's product caution that the software is not necessarily technically superior to Microsoft's.

"It might not be the 'full monty,'" Doherty said.

Still, sources said, it's unlikely that AT&T would dump Microsoft outright, especially given that the software giant is a large partner and investor in AT&T. In addition, the cable industry is subject to sudden whims and changes in direction.

"You can't say a deal is imminent. That word doesn't exist in the cable industry's vocabulary," one source joked.

In recent days, Liberate's stock, along with that of other Microsoft competitors such as Excite@Home and OpenTV, has surged on speculation swirling about Microsoft's delays. Liberate shares shot up more than 15 percent today, to as high as $29.94, from a close of $24.44 yesterday, on news that BellSouth would use Liberate software in its satellite boxes.