I was coming in here to suggest that. I'll repost that over here:
I found a video app that can actually play divx encoded avi's smoothly. This one is playing at a full 24 frames per second and looks good.
It called RockPlayerBase and is currently in a closed beta. Here is a download of the app:
http://www.mediafire.com/?u3lwq2z5mzm
You will need to select allow non-market apps in settings to install it.