This does not mean Intel's efforts to make a desktop GPU are dead. It's just that, with the delays and performance/power issues of the first generation of Larrabee, it wouldn't be competitive with AMD's 5xxx series or Nvidia's unreleased Fermi.
So they'll do a second generation on an updated process node (32nm instead of 45nm) and a new architecture (won't be software-compatible with the first gen) and release it in 2011 or so. If the next consoles are to come out in ~2012, a GPU released in 2011 won't make it, and they can't prepare for it if the ISA is different and current silicon isn't competitive with AMD or Nvidia.
Intel also has to prove their drivers are good, and previous efforts with integrated graphics don't inspire confidence. I believe they will work it out, just not this year or 2010. They have almost unlimited time and money to get it right; it's part of their (and AMD's) strategy to put the CPU and GPU on one die eventually.
If it had been released against the 4870 and GTX260 when they launched [projected performance was 1TFlop, the 4870 did about that) and at that price and TDP, I imagine it would have been competitive.
And they'll still sell it in 2010 as an HPC card against Nvidia's Tesla and Quadro and AMD's FirePro.
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