The patent license fees were too high to enable MPEG support on the GPU, so it would have to be all software, better to convert it to H264 to get the native hardware support.
Acknowledged, but this has been known for ages. What I haven't seen is a definitive statement from someone with actual hardware, e.g. "I tried to play back a DVD ISO of "Mission: Impossible Ghost Protocol" from a USB HDD, but it failed any time the bitrate got over 4Mbit/sec".
In addition, MPEG 4 part 10 AVC / H.264 has various Profiles which are feature sets a decoder may support, and levels which determine bitrates, picture sizes and buffer sizes. (Furthermore, H.264 is a very complex codec so there may be specific features which a decoder does not support even though the spec says they should be supported for a given Profile.) So there will need to be some work done to determine the limits of what Raspberry Pi will support even with H.264 encodes.