Shares in LG Electronics plunged 14% on Thursday as the company announced a 1.06tn won (£590m) rights issue which will be used mainly to fund a revival of its loss-making smartphone business.

The South Korean company's shares have already fallen by more than 40% this year, but the decline as it announced the demand from existing shareholders was its biggest daily fall in more than three years, and knocked around £625m, or $1bn, off its market capitalisation.

LG's handset business has reported nearly 1tn won in losses over the past six consecutive quarters, as it has failed to introduce compelling models to challenge the likes of Apple's iPhone and Samsung's Galaxy line, both of which have significant shares of the smartphone market.

LG – which has made smartphones using both Google's Android and Microsoft's Windows Phone operating systems, but is now focussing more strongly on Google's platform – saw its smartphone market share fall in the July-September quarter, according to recent figures.

It managed to pass Sony Ericsson as the sixth biggest smartphone maker in the second quarter of the year, but even so only sold 5.4m units then, compared to Apple and Samsung which collectively sold around 35m in that period. However, LG is still the world's third biggest maker of branded Android smartphones, behind Samsung and HTC.

Losses from the handset division more than doubled to 140bn won (£83m) from the previous quarter, as its flagship line of Optimus products, powered by Android software, struggled to lure away consumers from competitors.

The company is being squeezed as customers migrate to higher-end smartphones from Apple or Samsung, or to cheap ones from Chinese companies such as ZTE. That is causing a "dumbbell-shaped" smartphone market in terms of value for manufacturers, says Stuart Jeffreys, analyst at Nomura Securities, who thinks that HTC could be vulnerable in the longer term as well.

Horace Dediu, of the analysis company Asymco, observed in June that "the strange fact [is] that as far as I've been able to observe, any company in the mobile phone market that ended up losing money has never recovered its standing in terms of share or profit".

He cited 13 instances from the past decade, all preceding both LG and Nokia's quarterly losses. He noted that Motorola and Sony Ericsson have also fallen into loss over the past five years.

"This cursory survey shows that it's difficult to be optimistic once a company reaches a point of crisis. It's a curious outcome given that the market is so vast and growth is so robust," Dediu wrote. "But the fact is that because of the technology cycle time, rapid business model evolution and fairly low barriers to entry, there is great rivalry between competitors.

"Profitability is the canary in the coal mine. It causes a brand to be tarnished in the eyes of distributors who, because of sales cycle times, are extremely sensitive to obsolete inventory. A loss maker is seen as a maker of damaged goods. It then turns off the tap of incentives, promotions and hence visibility in the eyes of consumers. It's a vicious cycle from which few (if any) can recover. Past greatness offers no succour."

LG stock is one of the worst performers among global handset makers, along with BlackBerry-maker Research in Motion and Nokia, although RIM has remained profitable through its life. It is also struggling to generate strong returns from its home appliances and TV businesses due to weak demand and soaring input costs.

LG said in a statement: "The rights offering is aimed at securing ample resources required to improve competitiveness of our core businesses. We'll continue to invest in our core businesses, including smartphones, to regain our initiative."

Analysts thought that it had taken a better approach than issuing bonds or borrowing. "A share issue might be a better option from LG's point of view, since borrowing and issuing debt may turn out to be more costly," said Oh Dong-ge, a senior fund manager at Daishin Asset Management, which owns LG shares.

"LG is taking certain risks and it is betting on an already struggling smartphone business just when the operational environment is not friendly either. It is hard to say who might be interested in supporting this potential rights offer scheme, but my guess is it would be weak."

Koo Bon-joon, the younger brother of the LG Group chairman and a member of its founding family, took over as the CEO of LG Electronics a year ago to rescue the troubled mobile business.

The world's No.2 TV maker and third-biggest handset vendor said that it would place new shares worth 1.06tn won to existing shareholders at 55,900 won each, representing a 9.3% discount against the closing price in the South Korean stock market on Thursday.

But the company's credit rating has been cut this week by the agencies Fitch and Moody's to negative: Fitch said LG's operational competitiveness was unlikely to recover significantly in the short term. Standard & Poors also downgraded LG's long-term corporate credit rating, just as the company is struggling with deteriorating cash flow.

Shares in parent LG Corp fell 10% on concerns that LG Electronics may place a big chunk of the potential new share issue with the holding company.

LG Corp owns 35% of the electronics unit.

Shares in the lossmaking flat-screen maker LG Display fell 6.3%. "LG Display, which has been posting losses, needs fresh facility investments and LG Electronics, as the top shareholder, may need to pitch in," said John Park, an analyst at Daishin Securities.

LG Electronics controls around 38% of LG Display, the world's No.2 flat panel maker, which posted a record quarterly loss last month.

LG Display was also at the centre of a rights offer rumour, although a company executive denied last month in a meeting with investors.