* Apple introduces new version of $99 Apple TV
* Says TV show rental deals in place with ABC, Fox
* Challenges Google, Microsoft in race for Internet TV
* Unveils new lineup of iPods
* Shares of Apple up almost 3 pct, Netflix jumps 7.5 pct (Recasts, adds quotes, updates share prices)
By Bill Rigby and Noel Randewich
SAN FRANCISCO, Sept 1 (Reuters) - Apple Inc (AAPL.O) unveiled a smaller, cheaper version of its Web-to-TV device on Wednesday, stepping up a battle with Google Inc (GOOG.O) and Microsoft Corp (MSFT.O) for control of the digital living room.
Apple co-founder Steve Jobs also rolled out a completely overhauled lineup of iPod media players and the latest version of iTunes, with a new logo that does away with the outdated image of a CD.
The new Apple TV device, which accesses content from the Internet and plays it on a TV, will sell for $99. It is a quarter the size of the original, which cost $229.
The 4-inch-square device allows users to rent TV shows for 99 cents and first-run films for $4.99. Earlier models, which allowed users to only buy shows, failed to find a major audience.
"Consumers are already terrified of hooking anything up to their televisions, so unless you can make it crystal clear why they should and make it super easy for them to do so, you're limiting yourself to a niche market," said Avi Greengart, research director for consumer devices at Current Analysis.
The biggest shift to iTunes is the introduction of a social networking feature called Ping, which allows users to recommend songs to followers or their chosen circle of friends.
"It's Facebook and Twitter meets iTunes. It's a social network all about music," Jobs said at a presentation to unveil the products on Wednesday.
But the centerpiece of the event for reporters and investors was Apple TV, which the company introduced in 2006 but which never became a big hit.
Jobs once referred to Apple TV as a hobby, but made clear that the company is now ready to seriously focus on marrying the Web to TV, a combination that is also in the sights of some of the world's most creative and deep-pocketed companies, including Google, Microsoft and Amazon.com Inc (AMZN.O).
"They're beginning to shift the paradigm for a very entrenched behavior," said Altimeter analyst Michael Gartenberg, who attended the event. "TV viewing hasn't changed that much in 50 years. They're trying to shift that behavior the way they shifted phone behavior."
Alongside renting TV shows and movies, Apple TV users will be able to stream content from video rental site Netflix Inc (NFLX.O). Netflix shares closed 7.5 percent higher on Nasdaq.
Analysts were lukewarm toward the device, although Apple's shares rose almost 3 percent, roughly in line with a broadly higher Nasdaq composite index.
"What they showed was an improvement from what they had before, but it's not as far reaching as it could have been," said analyst Daniel Ernst of Hudson Square Research.
Others doubted whether users would pay to rent TV shows on top of their cable bill, and suggested TV networks would be wary of allying with Apple.
"The content companies have to be careful not to destroy any of the value to their ecosystem because the cable bundle is really valuable and breaking apart content into individual pieces is risky," said Laura Martin, analyst Needham & Co.
Rival Google is taking a slightly different path with its latest offering of Google TV, which allows viewers to search and watch programs, DVR recordings and the Internet in one fell swoop.
Some new TVs will come Google TV-ready, though plans are in the works to market a separate stand-alone device in the fall. Google is working with the cable and satellite distributors.
Jobs spent most of his presentation on a snazzier line of its iPod, which dominates the music- and media-player market with 275 million units sold, but has suffered moderating sales in recent years. Jobs has turned his attention toward the iPhone and more recently the iPad, which became an immediate success when it was launched in April.
The company has revamped its product line ahead of the key holiday sales season. Jobs called it the "biggest change in the iPod lineup ever."
But Rodman & Renshaw LLC analyst Ashok Kumar said the new products wouldn't stop his expectations for iPod sales to stop growing after this year as they will be cannibalized by sales of devices such as iPad and iPhone.
"We think this year the iPod category will peak and then start to decline," Kumar said.
The revised iPod shuffle has been updated to include playlists and buttons to navigate the volume, and is smaller than the previous model. Jobs said it would play 15 hours of music, and would come in five different colors at a price of $49.
The nano, the next model up, now includes FM radio and can hold 24 hours of music. It will be priced at $149 for the 8-gigabyte version or $179 for the 16-gigabyte model, Jobs said.
A third revised iPod model, the touch, will include a front camera and is thinner than the current model. It will be priced from $229 to $399 depending on storage, and will be available next week.
Apple stressed the FaceTime video chat function on the touch, and its ability to play games with advanced graphics, a move which puts the device in competition with existing mobile gaming devices such as Sony Corp's (SNE.N) (6758.T) PSP, Nintendo Co's 7974.OS DS, and the soon-to-be released Microsoft-powered phones that will run some Xbox games. (Writing by Paul Thomasch; Additional reporting by Jennifer Saba, Yinka Adegoke, Sinead Carew in New York, Alex Dobuzinskis in Los Angeles, Poornima Gupta in San Francisco; Editing by Richard Chang)