PC Panasonic Corp.

Fujitsu Ltd. (6702.TO) and Toshiba Corp. (6502.TO) are in talks toward a business tie-up of their mobile phone operations--and possibly a full merger--a person familiar with the matter said Friday, without giving details.

Such a merger would create the second largest player in Japan's large but nearly saturated domestic market, where makers are struggling to regain competitiveness and improve profitability by streamlining and consolidating. The industry also hopes to pool resources to compete with foreign rivals in promising overseas markets like China.

According to data from the Tokyo-based private research agency, MM Research Institute Ltd., a merger of the mobile phone operations of third-ranked Fujitsu and eighth-ranked Toshiba would give the combined entity a market share of about 18.7%.

This would put it in second place after Sharp Corp. (6753.TO), which had a 26.2% share of the Japanese market based on shipments during the business year ended March 2010. It would be well ahead of Panasonic Corp.'s (6752.TO) mobile phone unit, Panasonic Mobile Communications Co., which had a 15.1% share.

However, a merger still wouldn't give the new entity the scale to compete with their bigger rivals globally, with less than 1% market share combined, according to data from market research firm Strategy Analytics.

For the year ended March, Toshiba's mobile phone business racked up sales of about Y90 billion, but with an operating loss it didn't specify.

Fujitsu, which is more highly-ranked in terms of sales volume, didn't disclose its sales value.

On the Tokyo Stock Exchange Friday, Toshiba shares ended 2.2% higher at Y460. Fujitsu shares were up a more modest 0.9% at Y560.

A merger may benefit Toshiba more, said Ikuo Matsuhashi, an analyst at Goldman Sachs in Tokyo, as Toshiba's cell phone business is loss-making while Fujitsu's is profitable. But Fujitsu's profitability may be diluted depending on the share merger ratio, he said.

The Nikkei reported Friday morning that Fujitsu and Toshiba would likely set up a joint venture later this year to combine their handset operations, with Fujitsu expected to hold the majority stake.

Commenting on local media reports, Toshiba said in a press release Friday it was "working on various internal improvements in the mobile phone business through reform steps, but nothing had been decided as reported in the media."

Separately, Fujitsu said in a statement it was untrue the company had made a decision, as had been reported.

Fujitsu manufactures handsets for NTT DoCoMo Inc. (9437.TO), while Toshiba mainly supplies cell phones to KDDI Corp. (9433.TO). Combining engineering and know-how and using common software could lower costs and enhance competitiveness.

The talks take place against the backdrop of a shrinking domestic handset market and past failures by Japanese brands to gain a major overseas presence.

Like most Japanese players, Fujitsu and Toshiba will need to look abroad for future growth, even as they come under attack in the crowded home market from ambitious newcomers like Apple Inc. (AAPL), Research in Motion Ltd.'s (RIMM) Blackberry, and Taiwan handphone maker HTC Corp. (2498.TW).

Apple has shown with the strong performance of its iPhone that smartphones and other popular foreign models can do well in the once hard-to-crack Japanese market.

Softbank Corp.'s unit will start offering Apple's new iPhone model, the iPhone 4, later this month. It has been selling iPhones since 2008 and kicked off sales of the iPad on May 28.

Handset sales have plunged in Japan since 2008, when carriers reduced subsidies for new models. Sales of new handsets fell 4% to 34.44 million units in the fiscal year ended March 2010, according to MM Research. Compared with three years earlier, the total market is down about 30%.

This has led to a flurry of consolidation in an overcrowded market.

In 2008 Kyocera Corp. (6971.TO) bought Sanyo Electric Corp.'s (6764.TO) mobile phone operations. Earlier this month, NEC Corp. (6701.TO), Hitachi Ltd. (6501.TO) and Casio Computer Co. (6952.TO) joined forces to create a single mobile phone company.

Despite the mergers, Japanese companies are still dwarfed by foreign rivals such as Nokia Corp. (NOK) and Samsung Electronics Co. (005930.SE). According to Neil Mawston, an analyst at StrategyAnalytics, Fujitsu is the 16th largest handset vendor globally and Toshiba is the 22nd largest.

Fujitsu, a leading supplier of 3G Symbian smartphones in Japan, ships all its products domestically, while Toshiba is more diversified, shipping to parts of Western Europe.

-By Hiroyuki Kachi, Dow Jones Newswires; 813-6269-2789; Hiroyuki.Kachi@dowjones.com

(Daisuke Wakabayashi, Yun-Hee Kim and Ayai Tomisawa contributed to this article)

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