In Boreas’s Libery you will find the The Last Weresheep Pergament, starthing the Quest. The Wheresheeep Recipe in Frederick’s Hideout (Frederick’s Blood Stone Quest) also starts the Quest.
The Cave that the Pergament mentions is in the Lucalla Forst, if your Perception Spell is high enoth you find the Sheep after the Ice Portal. The Weresheep Ghost tells you that you can find the real Weresheep in the Phantom Forest. To get there you need to complete the The Hunt in Hunters’ Edge Quest.
The great “Kickstarter” Tree is in the North of the Phantom Forest (Level 16+) at x:144 y:301. Put a Stardust Herb (not Dust) at the Tree at the Legendary Weresheep apears. Better argue with it (Pet-talk), to leave you some Weresheep Wool, else you need to fight it
The Weresheep-Woll then be placed on the Element Forge in Hildebrand and you get the Weresheep Armor.