Hmmm.. I came across this problem before and had some troubles finding the solution. But hopefully, I found one. Though this method seem a bit complicated, I hope you can follow through since I'm using this method for embedding subtitles and converting mkv files to whichever format I want - dvd, xvid, etc. with the subtitles appearing just like how they appear when playing normally in MPCHM.
So here are the things you need to have installed to get started:
(you can google them, or if u can't find any i'll be willing to send you the files)
1.) MKVToolnix - a tool used for managing the contents of a mkv container. (subtitles, video, sound)
2.) MKVExtractGUI - an add-on to MKVToolnix that allows you to extract the contents of a mkv container with a GUI.
3.) AVIDemux - a cross platform video editor designed for simple cutting, filtering and encoding tasks.
4.) Video Converter (any / optional) - You can use any video converter to encode your files into several other formats not supported by AVIDemux.
To start off,
1.) Extract the the MKVExtractGUI files in the MKVToolnix installation directory.
2.) Start MKVExtractGUI.exe
3.) In the "Input" pane, select the mkv file you wish to work on with.
* doing this step, there will be several check boxes available in the content pane which should look like something like this:
[ ] Track ID 1 : video (V_MPEG4/ISO/AVC)
[ ] Track ID 2 : audio (A_AAC)
[ ] Track ID 3 : subtitles (S_TEXT/ASS)
4.) We are only interested in extracting the subtitles so, check only the box that says "subtitles".
5.) After checking, click on the Extract button just on the right side of the content pane.
6.) Unless you changed the output directory, the subtitle file will just be on the same directory of your avi. It will be either an ".ass" file or ".ssa" or some other subtitle format.
7.) Start AVIDemux
8.) Click on file > open > select the mkv file u want to work on with.
9.) Depending on the video format inside of the mkv, it will warn you with the "H.264 Detected" and asking you to use the other mode. Just select "NO". Selecting yes will cause problems with the encoded file.
10.) When you get an Index is not up to date confirmation, Choose YES to rebuild frame.
The video will now be loaded in the screen.
Since I don't have a PS3, I'm not sure if the PS3 can play xvid format files directly. AVIDemux can convert the mkv files into AVI-xvid format directly. Otherwise, use another Video Converter to convert the files into target readable format in which you want the video to be played.
11.) On the "Video" section in the upper left side, click on the drop-down button that says "copy" and change it to the encode format you wish to use. Assuming that the PS3 can play XVID files(sorry if i dont know if it can) Choose MPEG-4 ASP (Xvid).
12.) To customize the encode options, click on "configure". You will be presented with several options. The default options usually does the trick. Just adjust the Quantizer slider to suit your needs.
13.) After making adjustments to the video quality, lets now add the subtitles. But before that, lets switch the video display to output mode by clicking on the menu bar View > Preview > Output. This will allow us to see the final output including the subtitles once we have it added to the filters.
14.) Click on the "Filters" button. Then click "Subtitles on the lower left side". You will be presented with several filters. Anime Fansubs usually contain the ASS/SSA format subtitles. Double click the ASS.
15.) Select the subtitle file we extracted using the MKVExtract tool. Leaving other settings to default works just fine. Hit OK. Then hit Close. You can also hit preview for a quick preview of the output.
* It might take a while to load depending on how long the video is. Be patient.
16.) Make sure you have switched your video display to output mode. By clicking View > Preview > Output on the menubar.
17.) Play the video and see if the subtitles are there. (It should be) if it does not appear, then you are not in Output mode. If the subtitles still does not appear, Click on "filters", then click "preview". Subtitles should appear.
18.) When the subtitles are now there, Select the Audio format you wish to use just below the "filters" button. Xvid usually works well with MP3 format.
19.) Select the output container in the "Format" Section. XVID and MP3 works well with AVI as the container and works well in most cases.
20.) The save the file, Click on File > Save > Save Video on the menubar. Dont forget to add ".avi" to the file name since AVIDemux does not automatically do this for you. When your done with the file name, hit save.
21.) Wait for the encode to finish. Depending on the speed of your computer and your encode settings, it might take some time.
22.) When the encode is done, test the file on your PC, or on your PS3 and enjoy the subtitles.
Important Notes:
1 - Adjust the subtitle filter settings, especially the font scale if the subs appear to be too small or too large.
2 - Some video encode and audio encode format does not work if you choose the wrong container. (e.g XVid and Mp3 on a MPEG container) For DVD, choose DVD(lavc) and MP2(twolame), with MPEG-PS as a container. Then burn using a DVD authoring tool like Nero.
3 - If somehow you get errors, try other encoding formats as long as you use the correct container.
4 - If you dont have the subtitle font used in the mkv on your font directory, the subtitles will render using the default font. (I think arial or tahoma)
5 - The steps may be complicated at first, but when you get the hang of it, You can say to yourself that you saved a lot of effort.
6 - All software used in this process is free / opensource. You dont have to pay for commercial MKV to AVI subtitles applications and the likes etc.
7 - You can encode files in a que (if u have several files that need to be encoded while sleeping) by manually adding the filters for each file and clicking File > Add to job list for each.
8 - You need to extract the subtitles for each mkv you want to work on.
There might be some applications out there that does the job, but as of now, this is the one I find very flexible and easy. Most importantly - It works.
I hope this helps. Good luck with your encoding jobs.
I love watching anime subs on a HDTV too.