Mesenchymal stem cells (MSCs), suffering from diverse gene hits, undergo malignant transformation and aberrant osteochondral differentiation. Src homology region 2-containing protein tyrosine phosphatase 2 (SHP2), a nonreceptor protein tyrosine phosphatase, regulates multicellular differentiation, proliferation, and transformation. However, the role of SHP2 in MSC fate determination remains unclear. Here, we showed that MSCs bearing the activating SHP2E76K mutation underwent malignant transformation into sarcoma stem-like cells. We revealed that the SHP2E76K mutation in mouse MSCs led to hyperactive mitochondrial metabolism by activating mitochondrial complexes I and III. Inhibition of complexes I and III prevented hyperactive mitochondrial metabolism and malignant transformation of SHP2E76K MSCs. Mechanistically, we verified that SHP2 underwent liquid-liquid phase separation (LLPS) in SHP2E76K MSCs. SHP2 LLPS led to its dissociation from complexes I and III, causing their hyperactivation. Blockade of SHP2 LLPS by LLPS-defective mutations or allosteric inhibitors suppressed complex I and III hyperactivation as well as malignant transformation of SHP2E76K MSCs. These findings reveal that complex I and III hyperactivation driven by SHP2 LLPS promotes malignant transformation of SHP2E76K MSCs and suggest that inhibition of SHP2 LLPS could be a potential therapeutic target for the treatment of activated SHP2-associated cancers.