Currently, component (which is analog) is the the best HD output you can get for an Xbox 360. Support for HD DVD implies that HDMI (which is digital) will be coming. To watch some HD DVD's with content protection, you will need a digital interface like HDMI.
How do you add another optical drive to a system that already has one? Adding another box that needs its own power and will be almost as big as the Xbox 360 seems like the wrong way to do it. Plus, how will it connect to the Xbox 360? A quick check of the back of my Xbox 360 shows that the only open connector is for ethernet. The USB port is in use by my Wi-Fi network adapter.
My guess on how the add-on will work is in keeping with Microsoft's true agenda with the Xbox 360: to connect your TV to your computer. I currently can stream MP3's and photos to my Xbox 360 from my computer. If I had Windows Media Center or Windows Vista, I could also stream video to my Xbox 360. And with a fast enough network connection, I could stream HD video, even wirelessly.
So here is my prediction: Microsoft will release an external HD DVD player for a PC that connects via USB and has HDMI cables for the Xbox 360. Then the PC will stream the HD DVD to the Xbox 360. The first HD DVD player is currently selling for $499. An external HD DVD player for a PC should be cheaper since it doesn't have to worry about a user interface (done in software by Microsoft), a remote, networking, or power (might be able to get it from the USB port). Considering that I found a place offering the first HD DVD player for $399, I would not be surprised to see an external PC HD DVD player for $199.