A little late into the thread, here's what I have to say on all of this:
Compilation of Final Fantasy VII. As was stated earlier, "Sephiroth is the iconic villain of FFVII." I don't believe Sephiroth is undergoing Badass Decay, but to those who do, wouldn't it just be finalized if he was overshadowed by some third-rate predecessor like Genesis or Weiss? I'm not saying they're bad characters, but they were never designed to usurp Sephiroth, so if Sephiroth didn't make a reappearance, we'd have:
No conclusion.
A spoiling of the original plot.
An entirely new plot, completely unconnected to the original.
The last thing doesn't sound so bad, but it's essentially a giant asspull to make money. Now, while I don't like that criticism, because EVERYTHING is to make money, if it doesn't add to Final Fantasy VII in any way, it has no place in the Compilation.
Save that shit for Final Fantasy XIV.
The additions to the Compilation are numerous, & a tad superfluous, but they all keep up an engaging story. That's important.
Throw out all the hints that Sephiroth is going to come back, & you lose that edge. The Compilation will have, at last, become the self-fulfilling prophecy of overrated suckage that many people are determined to make it out as.
Now, Nomura has stated that the Compilation isn't over yet, but it's difficult to come up with new ideas. And I can see that. If you make Sephiroth a calculating & manipulative villain from the start, you have FFVII. If you do a prequal before he goes batshit insane, you have CC. If you have him show up at the end for a final showdown, you have AC.
I think that Nomura will be able to come up with something good, but that's just me. All of these recent titles strike me as not only setting something up, but polishing his story weaving skills for the big one(s?). Again, just me.
Now, as to the return of Sephiroth: Yeah, he can do it. As long as he retains will in the Lifestream, he will always have some power. Aerith showed that when she released Great Gospel to heal Geostigma, & the Case of the Lifestream: Black novella emphesizes this, among many other things about Sephiroth's character.
He has, in short, gone off the deep end. He considers memories of his childhood, his friends, & even his appearance "irrelevent." He's left with the basics: Hatred & pride.
If he follows suit with other villains like Genesis & Rufus, he will be redeemed in the end, & finally diffuse into the Lifestream, of his own free will. Jenova will likely still be around, but at an even MORE reduced threat level. I have mixed feelings about this, but this is the only way I can see Sephiroth being "defeated."
It is, however, not the only possibility for a resolution to him. It is just the only possibility that I can foresee.
Well, there you go. A TL;DR post for a TL;DR thread. Take it as you will, but it won't be a true sequal without Sephiroth. To make a point about how upstaging the original is not a good idea: How many people in this thread said they wouldn't play a game starring Genesis? There wasn't nearly as much objection to him being added as a party member.