Mitsubishi Heavy Industries <7011.T> and Hitachi Ltd <6501.T> are to combine their thermal power businesses to compete against overseas rivals Siemens and General Electric , which are winning deals even in the Japanese firms' backyard.
The deal, in which Mitsubishi Heavy will take 65 percent in a new company, also revives Hitachi's efforts to absorb some of its local rival's infrastructure business to give it the scale to expand beyond a stagnant home market.
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The announcement comes more than a year after the two firms called off talks to merge their infrastructure businesses. Talks to combine the thermal power businesses began late this summer.
The new company, with Hitachi taking the remaining 35 percent, will bring together the two firms' gas turbine and other fossil-fuel power generation equipment businesses, and will be completed by January 2014.
For now, it excludes nuclear power - where Mitsubishi Heavy has an alliance with France's Areva SA , the world's biggest maker of nuclear plants. But Mitsubishi Heavy CEO Hideaki Omiya told a joint news conference in Tokyo that his firm will explore partnerships in other areas with Hitachi, which has a nuclear power venture with GE.
"There are many Japanese companies today that are battling each other domestically and then again with foreign competitors," he said. "Instead of wasting our energy doing that, we should be banding together to become even bigger to take on our foreign rivals."
Hitachi CEO Hiroaki Nakanishi said the tie-up would help the firms become a global leader in a tough business climate and also beat back rising rivals from China and India. He added the deal turned Mitsubishi Heavy from a feared competitor to a trusted partner.
The proposed venture would have annual sales of 1.5 trillion yen ($18.3 billion), the Nikkei business newspaper said. In July-September alone, Siemens had revenue of $27.9 billion and GE posted sales topping $35.5 billion.
Mitsushige Akino, chief fund manager at Ichiyoshi Investment, said it looked like a good move for both firms and "since the new company will be better positioned to compete with global rivals, it would appear to be a good move for Japan, too."
Mitsubishi Heavy's power system business accounts for around a third of group sales and about 80 percent of group operating profit. In the latest quarter, power systems accounted for around 9 percent of sales at Hitachi.
The Japanese companies face tough competition from GE and Siemens in the fossil-fuel power business, which has been boosted in the aftermath of last year's nuclear disaster at Tokyo Electric Power Co's <9501.T> Fukushima plant that triggered a national outcry against nuclear power.
Japan's utilities have taken nuclear plants offline and now depend heavily on fossil-fuel facilities, holding competitive bids on gas turbine projects, which has opened up a previously guarded market to foreign players.
GE and Toshiba Corp <6502.T> beat out Mitsubishi Heavy to win a Chubu Electric Power Co <9502.T> contract to expand the utility's gas turbine combined cycle plant in September.
Under such competitive pressure and faced with stuttering global growth, Nakanishi has moved to streamline and shrink Hitachi's loss-makers such as TVs and consumer electronics.
One of Japan's sprawling industrial conglomerates, Hitachi at one time boasted close to 1,000 group companies making everything from hub caps and lawnmowers to hard disk drives and nuclear reactors. The group employs more than 323,000 workers.
Hitachi said earlier this month it would combine its Hitachi Cable Ltd <5812.T> and Hitachi Metals Ltd <5486.T> in a bid to trim costs. It also recently bought Britain's Horizon nuclear project from German utilities RWE and E.ON for $1.1 billion.
Hitachi's operating profit dropped more than 15 percent in July-September as a sluggish global economy dented demand and restructuring costs weighed on profits.
Profits at Mitsubishi Heavy, also Japan's leading aircraft builder, fell 35 percent in the six months to end-September, but the company has forecast full-year earnings will rise 8.3 percent to 130 billion yen ($1.59 billion).
Mitsubishi Heavy has also been in talks about taking a stake in ailing Danish wind turbine maker Vestas , analysts have said, and said on Thursday it will combine its forklift operations with those of Nippon Yusoki <7105.T>.
Shares of Mitsubishi Heavy jumped 3.9 percent to a 7-month closing high on Thursday, while Hitachi gained 2.9 percent to a 2-month closing high.
(Additional reporting by Mayumi Negishi, Lisa Twaronite and Tim Kelly; Writing by Dominic Lau; Editing by Ian Geoghegan)