Some people have experimented but not been successful at using an external hard drive. However, it has been reported that for a BMW (which should have the same or similar USB system), a hard drive works if reformatted using a special utility:
http://www.e90post.com/forums/showthread.php?t=80270
As Stiggy says, whatever music files you want to play must be unprotected. But if you already have an iPod, why not simply use it and bypass all these issues?