It has been reported that mesenchymal stem cells (MSCs) can transdifferentiate into Schwann cell-like cells by a series of treatments with a reducing agent, retinoic acid and a combination of trophic factors in vitro, and can transdifferentiate into myelin-forming cells to repair the demyelinated rat spinal cord in vivo. We now report that when co-cultured with dorsal root ganglion (DRG) neurons, MSCs were induced to transdifferentiate into Schwann cell-like cells that had ensheathed DRG axons. Following differentiation, MSCs underwent morphological changes similar to those of cultured Schwann cells and express GFAP and S100, the marker of Schwann cells. Moreover, 6 weeks later, MSCs wrapped their membrane around DRG axons. Further, initiation of myelination was observed in the co-cultured DRG neurons, which was determined by signals to MBP and this initiation of axon myelination by MSCs is similar to that of Schwann cells. However, electron micrographs show that no compact myelin was present in the MSCs co-cultures, whereas the Schwann cells co-cultures had formed a multilammelar myelin sheath around the axon. These indicate that the release of cytokine by DRG neurons may promote the transdifferentiation of MSCs, but is not sufficient to elicit compact myelination by transdifferentiated MSCs. These results improve our understanding in the mechanism of MSC transdifferentiation, and the mechanism underlying ensheathment and myelination by transdifferentiated MSCs.