Speaking from my own use case, the bigger phone does not take over for the iPad. Not even close. I have the 7 plus, yet when I want to read a magazine, look at a book with photos (photography/food/landscape/art), look at or edit my own photos, look at photos on Flickr/Facebook, watch a video, read a comic, browse the web, multitask with two apps, use the Pencil to take some notes or touch up a photo on Pixelmator, I much prefer the iPad. If you are talking about the iPad Mini, then maybe your statement makes more sense, but the 9.7 inch or 12.9 inch screens > than a 5.5 inch screen for a lot of tasks.
Most people prefer larger screens. It makes it easier to see detail or fit more on the screen. Even reading a Kindle book on the 9.7 iPad feels like a better experience without page flipping nearly as often. That being said, a lot of what I mentioned can be done on an iPad 3.
They need to find a differentiating feature from the old iPads to get more people on board and to upgrade. As I mentioned, adding a Pencil isn't enough if the iPad is unable to run the Pro apps that people want to use the Pencil with. I am not sure that means a hybrid device, though I would buy one, but they have to at least give us more uses for the differentiating features.