I have just observed demonstration units of the V-Smile system . They have “educational games” aimed at ages 3-5, 4-7, and some similar ranges. The first thing I noticed was that children who were able to correctly play the games were a lot older than the designated ages. For example 10yo children were playing the Scooby-Doo addition game (supposedly teaching children to add single-digit numbers) and apparently finding the non-addition part of the game challenging (I tried it myself and found catching flying hamburgers while dodging birds to be challenging enough that it was difficult to find numbers). For children who were in the suggested age-range (and a suitable age for learning the basic lessons contained in the games) the only ones who actually managed to achieve the goals were the ones who were heavily directed by their father. So my observation is that the games will either be used by children who are too old for the basic lessons or be entirely directed by parents (I didn’t observe any mother giving the amount of assistance necessary for a 5yo to complete the games but assume that it happens sometimes).
I doubt that there are many children who have the coordination needed for a platform game who have not yet learned to recognise printed letters (as supposedly taught in the Winnie the Pooh game). The Thomas the Tank Engine spelling game had a UI that was strange to say the least (using a joystick not to indicate which direction to go but instead to move a cursor between possible tracks) and I doubt that it does any good at teaching letter recognition. There was also a game that involved using a stylus for tracing the outline of a letter, as I had great difficulty in doing this (due to the poor interface and the low resolution of the touch-pad) it seems very unlikely that a young child who is just learning to write letters would gain anything from it. Strangely there was a game that involved using the touch-pad to indicate matching colors. Recognising matching colors is even easier than recognising letters and I don’t think that a child who can’t recognise the colors would be able to manage the touch-pad.
The V-Smile system seems to primarily consist of a console designed for connection to a TV but also has hand-held units that take the same cartridges. The same company produces “laptops” which sell for $50 and have a very low resolution screen and only the most basic functionality (and presumably other useless games).
Sometimes the old-fashioned methods are best. It seems that crayons are among the best tools for teaching letter recognition and writing.
But if there is a desire to use a computer for teaching, then a regular PC or laptop should do. Letter recognition can be taught by reading the text menus needed to launch games. The variety of computer poker games can be used for recognising matching colors and numbers as can the Mahjong series of games. Counting can be taught through the patience games, and the GIMP can be used for teaching computer graphics and general control of the mouse and the GUI. NB I’m not advocating that all education be done on a computer, merely noting the fact that it can be done better with free software on an open platform than on the proprietary systems which are supposedly designed for education.
Finally with a PC children can take it apart! I believe that an important part of learning comes from disassembling and re-building toys. While it’s obvious that a PC is not going to compare with a Lego set, I think it’s good for children (and adults) to know that a computer is not a magic box, it’s a machine that they can understand (to a limited extent) and which is comprised of a number of parts that they could also understand if they wanted to learn the details. This idea is advocated by Gever Tulley advocates such disassembly of household items in his TED talk “5 dangerous things you should let your kids do” . Gever runs The Tinkering School  which teaches young children how to make and break things.
Finally I just checked some auction sites and noticed that I can get reasonably new second-hand laptops for less than $300. A laptop for $250 running Linux should not be much more expensive than a proprietary laptop that starts at $50 once you include the price of all the extra games. For an older laptop (P3) the price is as low as $100 on an auction with an hour to go. Then of course for really cheap laptops you would buy from a company that is getting new machines for their staff. It’s not uncommon for companies to sell old laptops to employees for $50 each. At a recent LUG meeting I gave away a Thinkpad with a 233MHz Pentium-MMX CPU, 96M of RAM, and a 800*600 color display – by most objective criteria such a machine would be much more capable than one of those kids computers (either V-Smile or a competitor).
Of course the OLPC  is the ideal solution to such problems. It’s a pity that they are not generally available. I have previously written about the planned design for future OLPC machines  which makes it a desirable machine for my own personal use.