You have it nearly right, you just have to replace char_handler by text_output_filter, and everything works OK.
I strongly suspect (I have to check) that what happens is that during the parsing, XML::Twig receives 3 events for the data element, 1 before the entity, 1 for the entity, and 1 after the entity. As of now, the char_handler is thus called 3 times, which might be considered a bug, I'll look into it. By using text_output_filter the substitution is performed later, once the 3 texts have been merged.
Does that solve your problem?
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