Touch gaming is great for certain types of games but physical buttons offer a totally different experience. I think a Playstation Phone could have been a big hit if Sony moved quicker. They're just way too late. At best we're going to see some Android games retrofitted with physical button controls and that's just not going to be very exciting. How are they going to convince developers to spend money targeting a non-standard Android platform that will reach so few users? I think the best bet for Sony would be to make Playstation the Android gaming brand. Work with Google to make stock Android the best gaming platform out there, work with handset makers to set some standards for input/GPUs/etc, license the PlayStation brand to Android handset makers, launch a PlayStation Android Store. Let other companies figure out how to get the hardware into people's hands. Does anyone doubt this device will be massively outdated before it even ships?
I think a phone with dedicated gaming buttons / sticks can be successful.
I doubt that we'll see many Android games retrofitted to the PSPhone. What would be the point for developers to do that? It is just limiting the market for your game.
The big push will be developed-from-scratch, PSP and PS2-ported games on the PSPhone. If SE does the emulators and such correctly, the phone will launch with a massive library.
The PSPGo and most recent Nintendo DS series systems were massively outdated when they shipped too. And it didn't stop them from being successful. If you look at the specs for those systems (processor, memory) it is laughable. The PSPhone has a 1GHz processor, 0.5GB RAM and decent 3D rendering performance... so it is going to last a long time, at least 5 years.
The other Android phone makers won't want to have dedicated hardware buttons for gaming... so they won't cooperate with SE, and frankly, SE doesn't want them either. They'd rather be the primary phone gaming platform all by themselves, or failing that, carve out a dedicated chunk of the market.