It can decode h.264 just fine, with 3rd party Video Players.
Dice Player on the Market works really well, but the "Paid" version seems to be gone at the moment. Dice player is awesome and plays everything I throw at it, but until the paid version shows back up, try out
MX Video Player. You may need the Tegra plugin to make it work, but try it out first without and see how it does.
Anand did a really good review testing all kinds of video codecs. He was able to play 1080p H.264 high profile streams at up to 40Mbps just fine.
Video Playback: Blu-ray Quality in a Tablet