I think you're right: demand would be low but probably steadly rising as the dedicated device would be a kind of halo product if done right (great design, great interface, easy of use, quality of video and audio);
I would produce a kind of design with the size between that of an iPod Touch and an iPhone 17 Pro made entirely of glass at the front and metal at the back (or also glass) allowing MagSafe but something akin to the iPod Classic. The front would have and infinite screen (finishing at the extremes) allowing for a full screen video playback. The bottom would have a USB-C port for charging, downloading of music and video and the back could or not have a camera (less cost if without) and the sides could have buttons for volume and power but the device should be IP57 or better.
I would like streaming services also but the device should be devoted to music, video, podcast, etc, like the original iPod, possibly allowing Safari and email but not mandatory in such a device.
The main objective would be to revive an iPod like if it was originally launched today in the spirit of the original! The interface could have some reminiscence of the click wheel and I would love if Apple launched a pair of EarPods Pro selling allongside the device that supported high-res audio in a kind of affordable way (about 99 USD)!