Toshiba Corp and Sony Corp are in talks to combine their units that make small and mid-size LCD panels for smartphones and tablet computers, and may sell a stake in the new entity to the Japanese government for about $1.2 billion, industry sources said.

The new unit would overtake Sharp Corp as the leading maker of small liquid-crystal display (LCD) panels, the Nikkei business daily reported earlier.

The government-backed investment fund Innovation Network Corp of Japan is in discussions with the two firms to invest about 100 billion yen ($1.24 billion) for a stake in the entity, the sources said on Tuesday.

Toshiba and Sony will aim to list the joint LCD panel business, the sources added.

The Nikkei said Toshiba and Sony are aiming to sell up to 80 percent of the unit to the government body.

The new company may use the funds to introduce cutting-edge production lines at a Sony plant in Aichi Prefecture's Higashiura, the Nikkei reported.

It will also develop technologies to mass-produce OEL (organic electroluminescence) panels, which deliver higher resolutions than LCD panels while consuming less power, the paper said.

Representatives from both Toshiba and Sony declined to comment on the matter.

Toshiba Mobile Display Co had 9.2 percent of the global small LCD panel market in 2010 while Sony Mobile Display Corp had 6.1 percent, behind top-ranked Sharp's 14.8 percent share, the Nikkei said.

Increasing demand for smaller panels used in popular devices such as Apple's iPad and iPhone last week led Sharp to forecast an unexpected jump in operating profit for its current business year.

Toshiba and Sony are seeking a basic agreement this month and the entity is expected to be formed later this year, the paper said.

(Additional reporting by James Topham in Tokyo, Arpita Mukherjee in Bangalore; Editing by Chris Gallagher)

Sony Smartphone