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Rumors have been coming fast and furious over the last month about Microsoft’s (NASDAQ:MSFT) entry into the digital music player business. The NY Times broke the story last week with multiple confirmed sources, turning rumors into fact.

Engadget has dug up some interesting rumors that go beyond what was reported in the New York Times today.

Microsoft’s new portable audio and video player will have a screen that’s “bigger than that of the iPod video” (which isn’t really saying much) and built-in WiFi so you can not only download content directly to the player, but actually participate in an Xbox Live-like social network that will help you connect with other people with similar taste and interests. Whether that’s going to be the Live Anywhere service they introduced at E3 we don’t yet know.

Microsoft has already sunk a huge investment in the Live service for interconnecting Xbox’s and creating a user community. It’s a very well received service. The new Windows Media 11 is also a sharp improvement and is planned to integrate into the Live network.

To attract current iPod users Microsoft is going to let you download for free any songs you’ve already bought from the iTunes Music Store. They’ll actually scan iTunes for purchased tracks and then automatically add those to your account. Microsoft will still have to pay the rights-holders for the songs, but they believe it’ll be worth it to acquire converts to their new player.

The dirty little secret about Apple (NASDAQ:AAPL) is that even though it is by far the #1 retailer of digital music, they simply just don’t make that much money from it. One billion songs on iTunes equals only one Billion dollars in revenue since the service was initiated. Apple makes far more money on selling the hardware. If Microsoft removes the biggest barrier to entry for consumers (sunk software costs) they could catalyze users, particularly Windows users, to switch to the Microsoft platform. One billion dollars is the kind of check only Microsoft (and maybe Google) can write.

Right now the new player is schedule to launch in November, but our source also tells us that Microsoft isn’t stopping with a WiFi-enabled PMP, they’re actually going to launch an MVNO next year using all Windows Mobile-powered HTC handsets. These handsets will let users connect to the same social network you’ll be able to access over WiFi using the portable media player.

This is huge. Microsoft is already the #1 provider of smartphone software in terms of unit volume (No, it is not Blackberry nor Palm/Treo). This was achieved by forging strong partnerships with hardware vendors like HTC (2498.TW), Motorola, and even Treo. This would allow the Live service to stretch virtually across every platform, from Cable set-top boxes running Windows Foundation, to Xbox 360’s, to small PMP’s to cell phones to desktop computers.

Too many people are attaching the term iPod killer to the new hardware Microsoft is working on. The real iPod killer will be the ability to scale the service across multiple platforms, something Apple simply cannot do, and it is an excellent example of the strength Microsoft can derive from its massive reach.

One thing that remains to be seen is what role Portalplayer (NASDAQ:PLAY) might play in the PMP device. Microsoft has been working closely with them to create a hardware/software sync platform called Sideshow and it is possible that this will be the basis for communicating with this new set of mobile hardware devices Microsoft is working on.

The PMP initiative is really about preserving Microsoft hegemony as the uber-platform. The pain would really be felt in companies like Apple, Real, Yahoo, Google who count on entertainment hardware and services for a big part of their future growth.

Microsoft has a pattern of entering a business and sucking the profit opportunity out of it by incorporating it as part of its platform. Why should entertainment infrastructure be any different?

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Source: Microsoft's iPod Killer Emerges -- Should Apple be Scared? You Bet! (AAPL, MSFT)