Great piece, Jez. Completely agree on the handheld opportunity from a business perspective. I don't know that I personally would get one -- my serious gaming tends to be planned for specific times with family when we're all together in the family room, at least right now. Nevertheless, I think you're exactly right on the opportunity and strategic reasons to do it.
Also, I think this actually ties even more tightly to Windows Phone, not just looking backward to the missed opportunity, but also looking forward to how they could still use gaming to help their own mobile needs: MS is in a unique position to leverage its gaming footprint to appeal to users for a mobile ecosystem. Combine that with Office and they could build a brand of "Work Hard. Play Hard" with the best in gaming and the best in productivity, all running on a new Surface Phone or mobile device.
I'd like to see them offer two mobile devices in the same family:
1. A Switch/Steam Deck-sized device, just as you've described, but with an option to include phone features (dialer, speakerphone, etc.) and a pair of Bluetooth earbuds that recharge inside the device (carrying around separate Bluetooth earbuds is an unnecessary hassle for a device that size)
2. A smaller pocketable device that like the Surface Duo, but with the full gaming features built-in and maybe some hardware controls in addition to the touchscreen (at the size, obviously can't be as good as the larger unit).
For the reasons I gave above, I wouldn't go for #1, but I would go for #2. If they offered a Game Pass Family plan with Cloud Gaming access for all family members with this device, I wouldn't just buy 1, I'd get one for each member of my family.
These should include optimal experiences for both Office and Xbox gaming. They should also put some work back into community competitive and achievement features like Gamerscore and ensure that at least all their own first-party games (now including all the King games) can feed into that, so that many gamers would want to use these devices to grow their score.
This is the right way to leverage the synergies in their respective areas of strength. Alas, I don't see that MS looks at any of their opportunities holistically like this. I think they believe that if you use Excel, you don't play games and vice versa, so instead of unifying these, they pit the two business units against each other like a Hunger Games fight when it comes time for their respective leaders' annual reviews. I can assure that most young adults think of themselves as gamers first and don't really care about the business features, but if you give them a way to have a prestige device for work that also provides the best mobile gaming experience, that's a winner.