TOKYO Fujitsu Ltd (6702.T) and Toshiba Corp (6502.T) are in talks to merge their mobile phone businesses, two sources said, in a move that would create Japan's No. 2 cellphone maker in a rapidly shrinking market.
The deal would allow the two electronics makers to share the heavy cost of developing phones in the technologically advanced market and analysts expect more consolidation.
"The Japanese market is not all that big, but there are still far too many manufacturers," said Mitsushige Akino, chief fund manager at Ichiyoshi Investment Management. "Consolidation will continue, even if at a slow pace."
If the two makers combine their operations, the Japanese handset industry would have six groups, down from 10 three years ago. NEC Corp (6701.T), Hitachi Ltd (6501.T) and Casio Computer (6952.T) agreed to combine their mobile phone businesses last year and the venture started operations this month.
Japanese makers, the first to put cameras and Internet browsing on mobile phones, only have about a 3 percent combined global market share, according to research firm Gartner. The increasing popularity of Apple's (AAPL.O) iPhone in their home turf is also driving consolidation.
Japanese firms are teaming up to expand in the global market, where they are outmatched by bigger and more efficient rivals such as Nokia NOK1V.HE and Samsung Electronics (005930.KS). Smartphone makers including Apple and Research In Motion RIM.TO are also growing rapidly.
Most local makers ship small volumes exclusively to domestic operators, in contrast to Nokia, the world's largest handset maker, which mass produces models and supplies it to vendors worldwide.
Fujitsu and Toshiba will likely set up a joint venture and Fujitsu is expected to hold a majority stake in it, sources familiar with the discussions said. They spoke on condition of anonymity as the deal is not yet official.
Fujitsu spokesman Etsuro Yamada said nothing had been decided. He declined to say if the firms were in deal talks.
Toshiba, which has been hunting for ways to turn around its loss-making cellphone operations, said in a statement that nothing had been decided. Spokesman Keisuke Ohmori declined to comment further.
Deutsche Securities expects Toshiba and Fujitsu's cellphone sales to total more than 300 billion yen in the year to March 2011.
Cellphone sales in Japan shrank almost 40 percent in the last two years, driving mobile phone makers to target overseas markets and also to share development costs estimated as much as 10 billion yen ($110 million) per new handset.
"It's a good thing they are joining forces," said Akino. "In fact it would be better if they merged completely -- this is just a partial consolidation."
The merged operations would trail Sharp Corp (6753.T) in Japan and be ahead of Panasonic Corp (6752.T) and NEC Casio.
Japanese makers are consolidating, with Kyocera Corp (6971.T) buying Sanyo Electric's 6764.T cellphone operations and Mitsubishi Electric (6503.T) withdrawing from the business in 2008, but they are still tiny outside of their home market.
Nokia had a 35 percent share in the global cellphone market in January-March, followed by Samsung with 20.6 percent.
MM Research Institute analyst Hideaki Yokota said it would not be easy for Japanese makers to take on global rivals but they may have a chance depending on which markets they aim for.
"Samsung and the U.S. and European makers are already established in China. On the other hand, India and Africa brands are not so established, so there would be room for change."
Analysts and market participants say Japanese makers' technological advantage could help as demand for advanced phones increases. The launch of next generation LTE networks globally could also support their sales overseas.
Toshiba has been selling smartphones based on Microsoft's (MSFT.O) Windows in Europe.
Fujitsu manufactures handsets for Japan's biggest mobile phone operator, NTT DoCoMo Inc (9437.T), while Toshiba mainly supplies cell phones to KDDI Corp (9433.T), Japan's No.2 telecoms firm.
Fujitsu shares gained 0.9 percent, while Toshiba rose 2.2 percent. The broader market rose 1.7 percent.
(Additional reporting by Sachi Izumi, Isabel Reynolds and Nathan Layne in Tokyo and Shailesh Kuber in Bangalore; Editing by Anshuman Daga)