Nissan Chief Executive Makoto Uchida, left, and Honda President Toshihiro Mibe attend a joint news conference in Tokyo, March 15. AP-Yonhap

Honda and Nissan are in talks to deepen ties, two people said on Wednesday, including a possible merger, the clearest sign yet of how Japan's once seemingly unbeatable auto industry is being reshaped by challenges from Tesla and Chinese rivals.

A combined Honda and Nissan would create a $54 billion company with annual output of 7.4 million vehicles, making it the world's third-largest auto group by vehicle sales after Toyota and Volkswagen.

The two firms had already forged a strategic partnership in March to cooperate in electric vehicle development, but Nissan's deepening financial and strategic trouble in recent months has added more urgency for closer cooperation with larger rival Honda.

Nissan announced a $2.6 billion cost savings plan last month that includes cutting 9,000 jobs and 20 percent of its global production capacity, as slumping sales in China and the U.S. led to a 85 percent plunge in second-quarter profit.

"This deal appears to be more about bailing out Nissan, but Honda itself is not resting on its laurels," said Sanshiro Fukao, executive fellow at Itochu Research Institute. "Honda's cash flow is set to deteriorate next year and its EVs haven't been going so well."

Shares of Nissan, Japan's third-largest automaker, surged more than 22 percent in Tokyo trade on Wednesday, while shares of Honda, the second-largest, declined 2.3 percent. Shares of Mitsubishi rose 13 percent.

The automakers have been grappling with challenges from EV makers, particularly in China, where BYD and others have surged ahead.

The talks between Honda and Nissan, first reported by the Nikkei newspaper, would allow the companies to cooperate more on technology and help them create a more formidable domestic rival to Toyota.

The discussions are focused on finding ways to bolster collaboration and include the possibility of setting up a holding company, said the people, who declined to be identified because the information has not been made public.

The companies are also discussing the possibility of full merger, according to one of the people, as well as looking at ways to cooperate with Mitsubishi Motors, in which Nissan is the top shareholder with a 24 percent stake.

Honda, Nissan and Mitsubishi said no deal had been announced by any of the companies, though Nissan noted the three automakers had said previously they were considering opportunities for future collaboration.

French automaker Renault, a major Nissan shareholder, said it had no information and declined to comment.

Honda's market capitalisation is about $44 billion, while Nissan's is about $10 billion after price surge on Wednesday, meaning a full merger would be bigger than the giant $52 billion deal between Fiat Chrysler and PSA in 2021 to create Stellantis .

Taiwan's Foxconn, which manufactures Apple's iPhones and has been seeking to expand its nascent EV contract manufacturing business, has approached Nissan to take a controlling stake, Bloomberg News reported on Wednesday, citing a source with knowledge of the matter.

Foxconn did not immediately respond to a request for comment, while a Nissan spokesperson declined to comment on the report about Foxconn.

The emblem of Japanese automaker Nissan Motor is seen at a showroom in Yokohama, May 9. AFP-Yonhap

Changing landscape

Over the past year, an EV price war launched by Tesla and BYD has intensified pressure on any automakers losing money on the next-generation vehicles. That has put pressure on companies like Honda and Nissan to seek ways to cut costs and speed vehicle development, and mergers are a major step in that direction.

"In the mid- to long-term, this is good for the Japanese car industry as it creates a second axis against Toyota," said Seiji Sugiura, a senior analyst at Tokai Tokyo Intelligence Laboratory.

"Constructive rivalry with Toyota is a positive for the rather stagnating Japanese car industry when it must compete with Chinese automakers, Tesla and others."

Any merger would face significant U.S. scrutiny and President-elect Donald Trump has vowed to take a hard line on imported vehicles, including threatening 25 percent tariffs on vehicles shipped from Canada and Mexico. He could seek concessions from Honda and Nissan to approve any deal, auto industry officials said.

Honda and Nissan both produce cars in Mexico for export to the U.S.

Honda and Nissan would also have to work out how to integrate their different corporate cultures if they proceed with a merger, analysts said.

"Honda has a unique, technology-centric culture with strengths in powertrains, so there should be some internal resistance to the merger with Nissan, a competitor with a different culture that is now faltering," said Tang Jin, a senior researcher at Mizuho Bank. (Reuters)