Coalescence of the embryonic gonad in Drosophila melanogaster requires directed migration of primordial germ cells (PGCs) towards somatic gonadal precursor cells (SGPs). It was recently proposed that the ATP-binding cassette (ABC) transporter Mdr49 functions in the embryonic mesoderm to facilitate the transmission of the PGC attractant from the SGPs; however, the precise molecular identity of the Mdr49-dependent guidance signal remained elusive. Employing the loss- and gain-of-function strategies, we show that Mdr49 is a component of the Hedgehog (hh) pathway and it potentiates the signaling activity. This function is direct because in Mdr49 mutant embryos the Hh ligand is inappropriately sequestered in the hh-expressing cells. Our data also suggest that the role of Mdr49 is to provide cholesterol for the correct processing of the Hh precursor protein. Supporting this conclusion, PGC migration defects in Mdr49 embryos are substantially ameliorated by a cholesterol-rich diet.