Honda and Nissan are in talks to deepen ties, media reports 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 US$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 US$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 US 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 closed nearly 24 percent higher in Tokyo trade on Wednesday, while shares of Honda, whose market value of US$43 billion is more than four times bigger than that of Nissan, declined three percent.

Shares of Mitsubishi gained nearly 20 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 and Mitsubishi 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.

The three Japanese automakers are expected to hold a joint news conference in Tokyo on Monday, according to a source familiar with the matter. (Reuters)