Sonic has been unable to keep up Sega sales
The maker of Tekken computer games Namco has offered to merge with troubled rival Sega to create Japan's largest games software company.
Sega, the creator of Sonic the hedgehog, has said it would look at Namco's proposal.
A merger between the two would kill-off a merger between Sega and Japanese pinball-style "pachinko" machine maker Sammy, which is due to be completed in October.
Sammy would effectively bail-out financially troubled Sega, thereby taking over the company, but the deal has been criticised by investors and analysts.
News of the merger talks saw Namco shares gain 1.3% and Sega's jump 15.7%.
Cost cutting deal
A tie-up between Sega and Namco merger would create the fifth biggest operator in Japan with 10% of the market and annual sales of 350bn yen (£1.85bn; $2.9bn).
"We are certain that consolidation of the two companies'
operations in every business field would bring about maximum synergy effects," Namco said in a statement.
A merger is expected to involve a restructuring to cut costs and jobs.
Sega, which has recorded its fifth consecutive annual net loss, recently cut its profit forecast for the year to March 2003 by 90%.
The two, whose arcade games units already co-operate, held merger talks last year but Sega pulled out.