It comes from an old cartoon in 'Punch' at which the host of a dinner party comments to his guest, the curate, 'I'm afraid you have a bad egg,' and the curate replies, 'That's alright, parts of it are excellent'. So the phrase refers to something that has both good and bad qualities. I've seen the caption mis-quoted many times, so here's a link to the actual cartoon on the Punch site:http://www.punch.co.uk/shop.asp?type=cartoon
The phrase comes from a 19th century cartoon in the magazine "Punch" of a curate eating an egg which is obviously bad, but assuring his companion (who has presumably provided said egg for him) that "parts of it are excellent". Colloquial usage has slightly altered the meaning so that instead of implying something fundamentally rotten, it now implies something not quite so bad, but with a mixture of good and bad parts.
The real point is that it is not just any old 'host' who has provided the bad egg...it's the Bishop himself! (The website offered refers to the 'Right Reverend' host.) Naturally, there is no way a curate would want to offend his bishop and hence his pretence that the egg is only partly bad.
I think Diogenes is being rather cynical, not everything is perfect. Colloquial usuage still tends to apply it to things which are good in parts, not things that have no redeeming qualities at all.