"Upconversion" and "upscaling" are often used interchangeably, referring to the process of taking a "normal" DVD signal (720x480i) and changing, or upconverting, it into a native 720p/1080i/1080p signal which is sent directly to an HDTV. The process involves two key elements: de-interlacing (the i in 480i stands for interlaced) and scaling (taking the image described by the DVD and sort of stretching it, by copying and averaging the colors of adjacent pixels in the source, aka interpolation, for example, to fill all the extra available pixels that your fancy-pants HDTV has). The quality of the upconversion process, in general, can vary on the chips used. Googling or searching this or other forums will give you more information.
What can the PS3 play? Blu-ray discs (BDs), for all intents and purposes are the same as HD-DVDs (technically they can hold more data, making them superior, but in practice, so far, most BDs are the 25GB versions, comparable to HD-DVDs), and regular DVDs, and it will upconvert DVDs. Well, technically, the PS3 doesn't actually do the upconversion; it relies upon the video processor built into your TV. Don't fret, every HDTV has one; it's how you watch all those non-HD cable channels... But the end result is an "upconverted" DVD signal that does look better. Not the best, like an Oppo, but better than "regular" DVD players.
The PS3 will not play HD-DVDs. I suppose you could consider this a disadvantage, but there's only one player that plays BDs and HD-DVDs, the BH100 made by LG and has an MSRP of $1200, I don't really think it's fair.
CNET has said that given the PS3 a very high rating, much due to its features outside of playing games. I have a PS3 and enjoy it thoroughly. The percentage of people for whom it would not make a great player is small.
Regarding BDs and HD-DVDs, there is A LOT of new technology, much of which is not even useable right now, such as new colorspaces, 2560x1440p resolution, bitstream HD audio, etc. For the "audio and A/V enthusiasts", these new discs offer extended benefits that can be experienced with specialized equipment. I mean, you can watch a Blu-ray or HD-DVD disc on a 20-year-old TV... but it won't be in HD; you need an HDTV. The same is true for the audio. For the "average consumer"***, the only drawback currently is the price, although considering that it's currently one of the least expensive BD players available, it's more of an asset than a liability. And btw it plays games, lets you store your music and video and picture collections, has a Web browser, etc.
*** If you ______________, you are an "average consumer":
- listen to movies using the speakers on your TV
- bought a Home Theater in a Box speaker system
- don't know what the different versions of HDMI mean (or weren't aware of versions at all)
I hate making such generalizations, mostly because it's not for me to make... and hopefully I haven't offended anyone, but I think that effectively weeds out the Geek Squad members among us. I'll explain the criteria: the speakers on the TV don't give you surround sound, duh; unless you spent $1500+ on a HTiB, I'm not sure that the speakers will yield a noticeable difference between lossy and lossless audio soundtracks; while all versions of HDMI can carry 8 channels of PCM data, only version 1.3 can carry encoded bitstreams for DTS-HD MA and Dolby TrueHD.
Again, there is only a small group of people for whom the PS3 is insufficient. I gotta go right now, but if you want to know, just ask.