Here, I \smashed the outer \underbrace of the 2nd line and added \vphantom of the same size as the inner \underbrace. That way, the \right\} picks up on the \vphantom height.
Note that because the outer \underbrace was \smashed, you will likely have to add a small \vspace after the equation to make up for the space taken up by the outer \underbrace, as shown in my MWE.
\documentclass{article}
\usepackage{amsmath}
\begin{document}
\begin{align}
\mathbf{Q}=\text{diag}&\left\{\text{diag}\left\{\underbrace{\mathbf{m}_1, \
\mathbf{m}_2,\ \ldots, \ \mathbf{m}_K}_{K}\right\}\right., \ \ldots\notag\\
&\quad \left.\smash{\underbrace{\ldots, \ \text{diag}
\left\{\underbrace{\mathbf{m}_1, \ \mathbf{m}_2,\ \ldots, \
\mathbf{m}_K}_{K}\right\}}_{N_x}}\vphantom{\underbrace{m_1}_{N_x}}\right\}
\label{eq:Q}
\end{align}
\vspace{\baselineskip}
xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
\end{document}

To follow up on a comment by the OP, if one wanted the braces on the inner diag arguments to be smaller, one could use the same technique I used on the outer diag. However, in this case, I think I would use something like \bigg\{ ... \bigg\}, which I show in the first line of the MWE below, or else \big\{ ... \big\}, which I show in the second line.
\documentclass{article}
\usepackage{amsmath}
\begin{document}
\begin{align}
\mathbf{Q}=\text{diag}&\left\{\text{diag}\bigg\{\underbrace{\mathbf{m}_1, \
\mathbf{m}_2,\ \ldots, \ \mathbf{m}_K}_{K}\bigg\}\right., \ \ldots\notag\\
%
&\quad \left.\smash{\underbrace{\ldots, \ \text{diag}
\big\{\underbrace{\mathbf{m}_1, \ \mathbf{m}_2,\ \ldots, \
\mathbf{m}_K}_{K}\big\}}_{N_x}}\vphantom{\underbrace{m_1}_{N_x}}\right\}
\label{eq:Q}
\end{align}
\vspace{\baselineskip}
xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
\end{document}

\leftand\right. – Werner Sep 10 '14 at 23:41m_1,\dots,m_KmakesKelements? IMHO it's a bit ridiculous. If you get rid of these inner\underbraces, you'll be fine then, won't you? – yo' Sep 10 '14 at 23:57