The hard-drive unit, Hitachi Global Storage Technologies (HGST), is the world's No. 3 hard drive maker and analysts said it could be valued at about $3 billion, based on its revenue over the last 12 months and the value of its main competitors, Seagate Technology Plc and Western Digital Corp .
Bankers are in discussions with the Japanese company about an IPO and underwriters could be named in early September, the sources said. Unofficially, Goldman Sachs Group Inc has been chosen as one of the underwriters, they said.
Although an IPO is the most likely scenario, Hitachi is also considering a sale of all or part of HGST, several sources said.
Shares in Hitachi, Japan's biggest electronics conglomerate, rose 2.1 percent on the news, outperforming a steady Tokyo electrical machinery sector subindex <.IELEC.T>.
Hitachi, on track for its first annual net profit in five years, has been streamlining its sprawling operations that include 900 group firms to focus more on stable and growing infrastructure-related businesses such as power plants and industrial systems.
As part of the effort, it made five then-listed subsidiaries into wholly-owned units earlier this year, while reducing its stakes in other units such as those make chips and mobile phones, judging they fall outside of its focus areas.
An independent business structure is ideal for a business like this one where price volatility is so severe and there is the need for such big capital investment, a Hitachi executive who declined to be named said of the hard disk drive unit.
The company has also said it is targeting acquisitions in IT service providers, particularly in Europe and the United States.
A Tokyo-based Hitachi spokesman said: We have not made any decision on the future (of HGST). Our stance from before -- that we have been exploring various possibilities for the direction of the business -- has not changed.
Analysts said a trade sale of the business could also be an option, given the struggling U.S. IPO market and a sudden surge in tech-related M&A activity. Bankers have said more companies are now pursuing both options simultaneously.
Hitachi moved to raise about $4.5 billion last year to shore up its battered capital base by issuing new shares and convertible bonds, its first public offering in 27 years.
Some analysts have said shedding the business could help the company's overall finances.
They are sort of cash-strapped, so this would get money to the firm, it would help them financially, said Hemant Hebbar, an analyst with Wedbush Securities.
The outlook for the hard disk drive industry is uncertain, with PC demand seen weaker than previously expected, especially among consumers in mature markets. Intel Corp last week warned of a sales shortfall in the third quarter.
HGST turned profitable in 2008 for the first time since it was founded in 2003 after Hitachi bought IBM's hard disk drive operations.
HGST posted an operating profit of $186 million on revenue of $1.5 billion for the 2010 second quarter.
Noble Financial Group analyst Mark Miller said some of HGST's business decisions in the quarter -- including boosting production in a tight market -- could be viewed as an attempt to gain market share and prepare for a spinoff.
But HGST's high output led to lower hard drive prices for the overall industry and could end up hurting HGST's valuation. Analysts noted that rivals Seagate, the No. 1 hard-drive manufacturer by revenue, and Western Digital are trading at historically low price-to-earnings ratios.
Weak markets have depressed valuations and spurred increased M&A activity. Miller said there had been speculation in recent months that Web giant Google Inc or infrastructure systems provider EMC Corp could buy a hard drive manufacturer to get an internal supply of drives for their data systems.
But he said the speculation has cooled recently as hard drive prices have declined.
In 2007, when HGST was mired in losses, Hitachi looked into selling a stake in the unit to investment funds such as U.S. private equity firm Silver Lake, according to sources.
Hitachi President Hiroaki Nakanishi, who was then heading HGST, announced afterward HGST would rebuild on its own, but that he would not rule out one day receiving outside capital for the unit.
HGST is currently led by President and Chief Executive Officer Steve Milligan, who previously was chief financial officer for Western Digital.
(Additional reporting by Clare Baldwin and Ritsuko Ando in New York and Kentaro Hamada, Sachi Izumi and Taro Fuse in Tokyo; Editing by Lincoln Feast)