LG Electronics, South Korea's loss-making handset maker, plans to issue new shares worth around $891 million to improve its cash flow, a source with knowledge of the matter told Reuters on Thursday.

Shares in LG Electronics Inc shares plunged 14 percent on Thursday, their biggest daily fall in more than three years, on concerns a new share sale would further dilute shareholder value, which has already slipped more than 40 percent so far this year. The decline lopped off around $1 billion of the company's market value on Thursday.

The source said LG was planning a rights offer of up to 1 trillion won ($891 million) to boost its cash flow because the firm is reeling from heavy losses from its handset and flat-screen businesses.

The source declined to be named because the plan has yet to be officially announced.

An LG Electronics spokesman said he was looking into the report. The Korea Exchange asked LG to clarify by 0900 GMT (5 a.m. EDT).

Koo Bon-joon, the younger brother of the LG Group chairman and a member of its founding family, was brought in a year ago to rescue the troubled mobile business, but he has so far failed to turn around the operation.

LG's handset business recently reported losses for a sixth consecutive quarter, totaling nearly 1 trillion won, as it has failed to introduce compelling models to challenge the likes of Apple Inc and Samsung Electronics Co.

A worsening credit outlook in recent weeks has triggered speculation the world's No.3 handset maker may need to raise equity capital to support the loss-making business.

Ratings agency Fitch this week joined Moody's in cutting the credit outlook on LG Electronics to negative, citing weak operating results and said its operational competitiveness was unlikely to recover significantly in the short term.

S&P also downgraded LG's long-term corporate credit ratings, just as the company is struggling with deteriorating cash flow.

Any new share issue will further depress LG shares, which have lost more than 40 percent this year. The stock is one of the worst performers among global handset makers, along with Research in Motion and Nokia.

A share issue might be a better option from LG's point, since borrowing and issuing debt may turn out to be more costly, said Oh Dong-ge, a senior fund manager at Daishin Asset Management, which owns LG shares.

LG is taking certain risks and it is betting on an already struggling smartphone business just when the operational environment is not friendly either...It is hard to say who might be interested in supporting this potential rights offer scheme, but my guess is it would be weak.

LG Electronics, the world's No.2 TV maker and third-biggest handset vendor, is also failing to generate strong returns from its home appliances and TV businesses due to weak demand and soaring input costs.

LG GROUP SHARES PLUMMET

Shares in parent LG Corp fell 10 percent on concerns LG Electronics may place a big chunk of the potential new share issue to the holding company.

LG Corp owns 35 percent of the electronics unit.

Shares in loss-making flat-screen maker LG Display fell 6.3 percent.

Traders said LG Electronics may be seeking to raise money to prop up struggling affiliates such as LG Display or an M&A deal.

LG Display, which has been posting losses, needs fresh facility investments and LG Electronics, as the top shareholder, may need to pitch in, said John Park, an analyst at Daishin Securities.

LG Electronics controls around 38 percent of the world's No.2 flat panel maker, which posted a record quarterly loss last month.

LG Display was also recently at the center of a rights offer rumor, which a company executive denied last month in a meeting with investors.

($1 = 1121.850 Korean won)

(Additional reporting by Ju-min Park; Editing by Jonathan Hopfner, Miyoung Kim and Matt Driskill)

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