Good point, Tim!
Whilst that picture is an obvious artist's conception (the keypad just looks badly Photoshopped) it would be a pretty nifty idea. It could accept UMD discs like the PSP, so could be a viable rival.
But, like the PSP, the full-sized X-Box/X-Box 360 would not be compatible, so consumers will have to buy the games again in their handhel X-Box form. And because of the downscaling, cost would go through the roof, so I don't think it's a viable option.