The default application for videos on a media director is Xine. It works usinge a plugin/player combination.
The plugin runs on the CORE in teh DCERouter memory space and effectively can stream the file. The Player runs on the Media Directors and either plays the stream or if there is only one consumer I think it opens the file URL directly.
I can't see any reason why codecs can't be upgraded, they can be added.
Let us know you results, wiki entry would be great and I guess add a Mantis as a feature request to get it in the next release as well.