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I truly hope this rumor remains just a rumor, but it seems that Microsoft has been thinking about the possibility of a Zune phone. A Microsoft CFO made a statement recently regarding this, saying the concept of Microsoft producing a handset isn't unreasonable.
Why, exactly? The Zune, while it isn't failing, has not had anywhere near the success Microsoft hoped. What Ballmer said months ago is more true to reality than the idea of a Zune phone, and that is coupling more "Zune" features into their already successful Windows Mobile. While Microsoft themselves do not have a handset, many smartphones do rely on Windows Mobile. Perhaps they have some leverage there - and indeed it may make a lot of sense to extend features on it like this.
Apple does have a huge one-up on Microsoft, and that is their ability to promote and get people interested in new gadgets. The Zune is definitely no iPod killer, and a zPhone would probably meet with the same fate.