Analysts also viewed the move as a Toyota-led consolidation that was likely to draw in KDD Corp, a struggling international carrier that is 8.2 percent owned by the automaker.

Competition has intensified in Japan's telecoms sector since third-largest carrier Japan Telecom concluded a deal with British Telecommunications Plc and AT&T Corp earlier this year giving the two foreign giants a combined 30 percent stake in the company.

Industry leader Nippon Telegraph and Telephone Corp, a former state-run monopoly whose consolidated affiliates include top cell-phone carrier NTT Docomo, restructured itself as a holding company in July in a bid to cut costs and step up international expansion. A merger with IDO "would cement DDI's position as the second-largest cell-phone companybehind Docomo," said Hironori Tanaka, analyst at Morgan Stanley Dean Witter.

He also saw potential benefits from closer ties with KDD.

"DDI up until now has not had an optic fibre network and sohasn't been able to branch out into the data transmission business," he said. "But if it ties up with KDD it will have this. It will of course lag behind its competitors but it has sufficient potential to catch them up."

A DDI spokesman said on Tuesday his company was mulling a merger with Nippon Idou Tsushin Co, better known as IDO, but no decisions had been made.

Financial daily Nihon Keizai Shimbun reported in its Tuesday morning edition that the two companies were in the final stage of merger talks, stoking expectations that emerged in April when the two launched a joint digital cell-phone service.

Tanaka said the combined firm would have nationwide mobilephone coverage, while access to Toyota's mountain of cash could help it meet massive capital spending requirements in the future and reducebalance-sheet risks.

But analysts also voiced concerns that DDI and the Toyota-linked firms were coming together out of weakness.

"We remain sceptical," said Thomas Rhodes, an analyst at Dresdner Kleinwort Benson. "While this is a merger of survival, this is not a merger of shareholder value creation."

He said DDI's cellular operations have a net profit margin of less than one percent and IDO is not much better, while KDD has a net profit margin of less than one percent on over 400 billion yen ($3.74 billion) in sales .

"On an international comparison those net profit margins are absolutely unacceptable," he said.

But investors reponded enthusiastically to the news, with DDI's share price rising 10 percent at one point in mid-afternoon trade. At 0415 GMT DDI traded at 865,000 yen, up 8.26 percent or 66,000 yen from Tuesday's close.

KDD's shares were up 390 yen or 3.86 percent at 10,490, afterjumping in the morning to a new high for the year of 10,740, up 6.34 percent.

Toyota, Japan's biggestautomaker, has repeatedly said itwants its non-automotive divisions to account for at least 10 percent of consolidated revenues going into the new millennium.