Few comments on this great idea (quite possibly, some of them have been mentioned already, sorry if thats the case):
1) German-French & British cooperation should not be overly quick or optimistic. Its not that Nazis disliked French and envied British, its the Germans. Germans wanted Alsace-Lorraine and to be as influential as the British. Having Democracy in Germany will not cancel those ambitions. And, some of the things that Hitler did, like, cancelling and ignoring Verrsailles treaty was not his idea, it began with Stresemann, so, Hitler just moved those things to the extreme. Germany would still have violated Versailles treaty, after all, they already did that in 20s, by cooperating with Soviet Union. Here's a nice quote from Wikipedia on that:
"Alongside the Soviet Union's military and economic assistance, there was also political backing for Germany's aspirations. On July 19, 1920, Victor Kopp told the German Foreign Office that Soviet Russia wanted "a common frontier with Germany, south of Lithuania, approximately on a line with Białystok".[citation needed] In other words, Poland was to be partitioned once again. These promptings were repeated over the years, with the Soviets always anxious to stress that ideological differences between the two governments were of no account; all that mattered was that the two countries were pursuing the same foreign policy objectives."
So, while Democratic Germany would not be as aggressive as Nazi one, still, they would pursue: long-term goal of destabilizing Poland in order to regain corridor and re-establish to influence of Germany in the world. That does include slowly pocking at Versailles, searching for holes and testing Allies (Hitler did the same, but just far more bluntly and violently), thus, that includes looking for options to revive German armed forces. And, if UK and France were so sheeply and slow with Hitler, then how slow and ignorant could they be with democratic, diplomatic and calm Germany? I think, for Weimar or Democratic Germany to re-establish its armed forces *could* realistically take 5-10 more years, but they could have done it anyways. After all, France and Poland already in 20s new very well what tanks and plans were Germans making on the territory of USSR. So in 30s that would slowly leak into public knowledge, thats it - so why pretend that Germany can't build its military forces? Allow to do it openly, with some formal check-ins and insurances.
Also, with no Nazis in Berlin to claim "racial superiority over slavs", cooperation with Stalin should continue on and on. After all, Ferdinand Foch in 1919 did say "this is not peace, this is armistice for 20 years", so, there was general understanding that Germany will search for revenge against Allies. So its Federal Republic of Germany postWW2 that jumped at the chance to integrate itself into the Western military block, but not Kaiser or Weimar Germany. After all, it would be almost like asking for a military coup by Prussian military aristocrats.
2) Nazi Austrian or Austro-Hungarian empire. Idea is: how about Hitler trying to re-establish the Austrohungarian empire, but on ideology of Nazism. So, this new empire or Reich being of master-race (Germans) ruling over sub-races (slavs). Without expelling or killing the slavs (since that would be impossible to accomplish, because of the small number of Germans in such a country), but just "properly ruling" them. So European-scale colonialism, like Soviet Union in Eastern Europe. The question remains of Hungarians, since, Hungarians would agree to and fully join such venture only if Nazi ideology would include Finno-Ugric people as well. So, this empire would have cores only in Austria (if cooperating with Hungarians, with adjustments to ideology, then Hungarian cores as well, but such cooperation should be somewhat difficult to achieve) but all the conquered lands - Czechoslovakia, Croatia from Yugoslavia. Transylvania probably should be cores because of Hungarians living there and Sudets having Germans but the Slavic regions (Czech, Slovak, Slovenian, Croatian, Bosnian) should not be Austrian cores.
And, maybe Nazi Austria should also have cores on all Germany, since, Austrian identity is kind of modern, postwar development.
3) Whats more, Nazi Austria should have either potential war later on (after getting alliance/puppet/full control in Hungary and Czechoslovakia) with Fascist Italy over the rule of Adriatic Sea coast, or, on the contrary, they could come to some agreement and divide Yugoslavia in alliance with Italy (and then have chance to backstab each other over the other few provinces). I assume no Allies would involve themselves with Fascist Italian-Nazi Austria war.
In fact, since historically it was the Hungary who was considered the "wild card" of the region, and thus, the Little Entente was formed against it, then in this scenario, it would be logical that this Little Entente is also formed to defend against Nazi Austria, and thus, Austria and Hungary are pushed to be very close allies, so, having them unite shouldn't be totally ASB.
4) So, at some point this re-established Nazi Austro-Hungarian Reich might either attack Democratic Germany or support Nazi side during the German civil war. However, openly attacking Democratic Germany should cause United Kingdom to offer help to Democratic Germany and thus, it might enter the Allies. Also, Czechs, Slovaks, Slovenians, and other subjugated people should jump at the chance of rebellion against the "enlightened" rule of Hitler.
5) Italians attacking Greece and then needing help to finish it might be a good reason for Nazi Austrian Reich to attack or occupy the Yugoslavia or whatever would be left of it.
6) Maybe at some point, if there is no general war and Nazi Austrian Reich is alone in Axis, Mussolini could get overambitious and attack France alone, without involvement of the rest of the Allies? Meaning, Allies generally existed to stop potential German aggression. In case of Italian aggression, I assume British would watch closely, but likely would not enter the war, unless, the war grows and includes Germany or one of the German factions. This might be especially the case if French, with no need to re-arm because of re-emerging German army, would have weaker army than historically. Italy still should have big chance to be beaten, but since, it wouldn't really be a total war, then they should loose just colonies.
7) I wonder what German-Polish relations would look in this scenario. I assume that with a long a persistent persuasion, Polish would finally, peacefully agree to corridor to East Prussia. However, if Soviet Union would at some point offer Germany division of Poland (as it already did in 20s), then, depending on the relations with Allies, maybe Germany might agree to that, but, USSR would probably have to attack Poland first, with Germany joining like USSR did historically - in a few weeks time. However, having this historical event reversed in-game would actually look like a bit of a lack of imagination..
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