Japan's NEC Corp, Hitachi Ltd and Casio Computer Co are in talks to merge their struggling cellphone operations to cut development costs in a saturated market, four sources said on Friday.

A union would help Hitachi and Casio lower their exposure to their dwindling cellphone businesses, and could trigger more consolidation among Japanese cellphone makers who are slugging it out in a crowded and shrinking market.

But mergers among loss-making cellphone businesses will not mean growth, an analyst warned.

Consolidation will at best mean that these handset makers stand still, said IDC analyst Michito Kimura, who expects the Japanese mobile phone market to shrink by 20 percent in 2009 for the second year in a row and stay flat next year.

The Yomiuri newspaper said NEC, Japan's No.3 handset maker, could split off its mobile phone division and merge it with an existing joint venture between Hitachi and Casio, taking a majority stake in the new entity.

The merger could be limited to the mobile phone development operations, and not include production, said the sources, who were familiar with the matter but were not authorized to disclose negotiations.

Shares in watchmaker Casio jumped 8.5 percent, hitting their highest level in nearly 11 months, while Hitachi rose 1.6 percent and NEC shares rose 0.6 percent.

Japan's mobile phone market is shrinking but phone makers still need to grapple with development costs estimated at roughly 10 billion yen ($107 million) per new handset in the world's most technologically competitive mobile market.

Most Japanese makers ship small volumes exclusively to domestic operators, in contrast to the world's largest handset maker Nokia Corp, which mass produces models that it supplies to vendors worldwide.

Japanese brands, who were the first to put cameras and wireless Internet browsing on mobile phones, together hold less than 10 percent of the global mobile phone market, and now face growing competition from Apple Inc on their home turf.

TRAPPED

The talks come as rivals Sharp Corp and Kyocera Corp scramble for a toehold overseas, despite warnings of price pressures and marketing costs by heavyweights Nokia and South Korean rival Samsung Electronics.

Sony Corp is the only Japanese mobile maker with a substantial global presence through a venture with Sweden's Ericsson.

NEC, which makes handsets for Softbank Corp and NTT DoCoMo, withdrew from China and Europe in 2007 after its technology-packed and pricey phones lost out to cheaper phones.

NEC, Hitachi and Casio, which issued statements saying that nothing had been decided on a merger, together controlled 20 percent of Japan's mobile phone unit sales in the year ended in March, according to research firm BCN Inc.

That would nudge out No.2 Panasonic Corp, which has a joint venture on phone development with NEC, and come a close second to Sharp, with 22 percent.

Hitachi, Japan's No.9 phone maker, supplies KDDI Corp, while Casio, Japan's No.8 phone maker, supplies KDDI and Softbank.

(Reporting by Mayumi Negishi and Yumi Otagaki; Editing by Chris Gallagher)

Japan Apple inc. Electronics