(Reuters) - In China, surplus capacity and sliding prices are sounding the death knell for half of the companies making light emitting diode (LED) chips used in Samsung television panels and Sharp computer monitors, with only the large, state-backed players likely to pull through.

Sluggish global sales of TVs and computers may further cut LED chip prices by 20 percent this year, and consolidation or closure are the only options for China's smaller LED players, analysts say.

By contrast, Sanan Optoelectronics Co Ltd, China's top LED chipmaker with a market value of $2.8 billion, and Elec-Tech International Co Ltd will be among a handful of large companies that will survive as they continue to receive subsidies and incentives from the government, according to analysts.

"That's China's strategy. They want their biggest companies to survive" in this restructuring, Nomura analyst Anne Lee said.

For the majority of LED firms, the government is slowly rolling back incentives, including tax breaks, free land and more than $1.6 billion in cash to buy LED chip-making equipment, that had helped sustain the industry for more than three years.

Proview International, whose Shenzhen-based unit is battling Apple Inc over the iPad trademark in China, is grappling with slumping LED prices and fierce competition that have dragged down earnings for other LED companies including Hangzhou Silan Microelectronics Co and Foshan Nationstar Optoelectronics.

Hangzhou Silan fell 2.9 percent to 10.10 yuan in Shanghai trading on Friday, while Foshan dropped 1 percent to 8.10 yuan on the Shenzhen exchange. The stocks were down more than 30 percent in the past year.

Many LED companies are operating their factories at 50 percent capacity in China, with up to half of the 700 or so chip-making machines purchased with government money during the boom years in 2009 and 2010 left idle, industry watchers say.

In the past year, overcapacity has shut hundreds of small Chinese makers of LED lighting, according to analysts.

"China's financial policy is not giving enough support to mid-tier and smaller enterprises," said Bao En Zhong, executive vice chairman of the semiconductor lighting association in Shenzhen, one of China's largest production bases for LED lighting. "We may see more factory closures."

BIGGER COMPANIES

Government subsidies helped China triple its global share in packaged LED components, consisting of chips, wiring and conductive paste, to 6 percent last year from 2 percent in 2010.

Sanan Optoelectronics said net profit more than doubled to 936 million yuan ($147.52 million) in 2011, thanks to government subsidies of about 1.8 billion yuan, analysts say. Elec-Tech's net income expanded two-fold to 392.3 million yuan.

Armed with nearly 2 billion yuan in cash in total, the bigger LED companies are ramping up capacity, despite a slow market, to better capture a larger share of state-backed LED lighting projects China plans to roll out this year, analysts said.

A UBS report said Elec-Tech had added 50 chip-making metal organic chemical vapor deposition (MOVCD) tools, used to produce LED chips, and may add 100 more this year. Sanan is also planning to buy more MOVCD tools, according to UBS.

China's Ministry of Science and Technology has said it plans to increase the value of the country's LED industry to 500 billion yuan ($79.10 billion) by 2015.

Analysts say the industry was valued at 31 billion yuan last year and consolidation is crucial to boost growth.

The death of weaker companies will also be a boon for bigger, state-backed LED firms looking to compete with regional rivals such as Taiwan's Epistar Corp and South Korea's LG Innotek at a time when many of their Asian peers have reported profit declines or losses.

NEAR-TERM OUTLOOK

A broad cyclical decline in demand for LED chips and a market that remains 50 percent oversupplied continue to weigh on prices and margins.

While the industry saw a seasonal increase in orders for LED chips early this year, fundamentals are still looking weak.

Sales growth at Taiwanese LED companies slipped to 3 percent in April month on month, after rising 12 percent in March from February, a UBS report showed.

Taiwanese LED companies account for about 19 percent of global output of packaged LED chips.

"We will see a real problem in demand due to reduced usage of LEDs in television and monitor units as backlight technology improves," said HSBC analyst Jerry Tsai. "Add to that a 20 percent fall in prices, you can just imagine the headwinds the industry will face next year." ($1 = 6.3447 Chinese yuan)