Switched to initdefault 3 in /etc/inittab and logged into Xen 3.4.2 host with your kernel. Set up VNC session and got the nice dmesg report, which is attached.

Yes , [drm]  entries for Radeon HD 4650 look good , but via remote VNC session.

[drm] Initialized drm 1.1.0 20060810
[drm] radeon defaulting to kernel modesetting.
[drm] radeon kernel modesetting enabled.
xen: registering gsi 16 triggering 0 polarity 1
xen_allocate_pirq: returning irq 16 for gsi 16
xen: --> irq=16
xen_set_ioapic_routing: irq 16 gsi 16 vector 152 ioapic 0 pin 16 triggering 1 polarity 1
radeon 0000:01:00.0: PCI INT A -> GSI 16 (level, low) -> IRQ 16
radeon 0000:01:00.0: setting latency timer to 64
[drm] radeon: Initializing kernel modesetting.
[drm] register mmio base: 0xFE8E0000
[drm] register mmio size: 65536
ATOM BIOS: 11X
[drm] Clocks initialized !
mtrr: type mismatch for d0000000,10000000 old: write-back new: write-combining
[drm] Detected VRAM RAM=256M, BAR=256M
[drm] RAM width 128bits DDR
[TTM] Zone  kernel: Available graphics memory: 4074962 kiB.
[TTM] Zone   dma32: Available graphics memory: 2097152 kiB.
[drm] radeon: 256M of VRAM memory ready
[drm] radeon: 512M of GTT memory ready.
[drm] Loading RV730 CP Microcode
platform radeon_cp.0: firmware: requesting radeon/RV730_pfp.bin
platform radeon_cp.0: firmware: requesting radeon/RV730_me.bin
[drm] GART: num cpu pages 131072, num gpu pages 131072
[drm] ring test succeeded in 1 usecs
[drm] radeon: ib pool ready.
[drm] ib test succeeded in 0 usecs
[drm] Radeon Display Connectors
[drm] Connector 0:
[drm]   HDMI-A
[drm]   DDC: 0x7f10 0x7f10 0x7f14 0x7f14 0x7f18 0x7f18 0x7f1c 0x7f1c
[drm]   Encoders:
[drm]     DFP2: INTERNAL_UNIPHY1
[drm] Connector 1:
[drm]   VGA
[drm]   DDC: 0x7e20 0x7e20 0x7e24 0x7e24 0x7e28 0x7e28 0x7e2c 0x7e2c
[drm]   Encoders:
[drm]     CRT2: INTERNAL_KLDSCP_DAC2
[drm] Connector 2:
[drm]   DVI-I
[drm]   DDC: 0x7e40 0x7e40 0x7e44 0x7e44 0x7e48 0x7e48 0x7e4c 0x7e4c
[drm]   Encoders:
[drm]     CRT1: INTERNAL_KLDSCP_DAC1
[drm]     DFP1: INTERNAL_UNIPHY
[drm] fb mappable at 0xD0141000
[drm] vram apper at 0xD0000000
[drm] size 5242880
[drm] fb depth is 24
[drm]    pitch is 5120
executing set pll
executing set crtc timing
[drm] TV-11: set mode 1280x1024 19
Console: switching to colour frame buffer device 160x64
fb0: radeondrmfb frame buffer device
registered panic notifier
[drm] Initialized radeon 2.0.0 20080528 for 0000:01:00.0 on minor 0

Attempt to run startx locally fails. Keyboard dies.
Please, advise.

Boris.