The two companies announced last August that they were discussing a possible merger to cope with tough price competition.

MatsumotoKiyoshi will initially acquire 20% of Cocokara Fine shares, the Nikkei said. Financial terms of the deal were not disclosed in the report.

Company representatives were not immediately available for comment, and trading in both of their shares were suspended in the afternoon.

With combined annual revenues of over 1 trillion yen ($9 billion) this year, a merger would make them even bigger than market leader Tsuruha Holdings, which forecasts 820 billion yen ($7.5 billion) in revenue this year.

Popularly known as "Matsukiyo", MatsumotoKiyoshi started as a mom-and-pop pharmacy in the 1930s. The chain pioneered discount cosmetics and became popular for a casual format which encouraged customers to sample products.

(Reporting by Ritsuko Ando; Editing by Christian Schmollinger & Shri Navaratnam)