xslt replace \n with <br/> only in one node?

Call this template on the string you want to process:

<xsl:template name="break">
  <xsl:param name="text" select="string(.)"/>
  <xsl:choose>
    <xsl:when test="contains($text, '&#xa;')">
      <xsl:value-of select="substring-before($text, '&#xa;')"/>
      <br/>
      <xsl:call-template name="break">
        <xsl:with-param 
          name="text" 
          select="substring-after($text, '&#xa;')"
        />
      </xsl:call-template>
    </xsl:when>
    <xsl:otherwise>
      <xsl:value-of select="$text"/>
    </xsl:otherwise>
  </xsl:choose>
</xsl:template>

Like this (it will work on the current node):

<xsl:template match="msg">
  <xsl:call-template name="break" />
</xsl:template>

or like this, explicitly passing a parameter:

<xsl:template match="someElement">
  <xsl:call-template name="break">
    <xsl:with-param name="text" select="msg" />
  </xsl:call-template>
</xsl:template>

I think you are working with an XSLT 1.0 processor, whereas replace() is a function that has been introduced with XSLT/XPath 2.0.