* AEI deal is latest in a series of M&A activity in city gas sector

* AEI China is controlled by Goldman, GIC and energy fund

* Deal implies 14 times AEI China's 2012 forecast earnings

By Charlie Zhu and Donny Kwok

HONG KONG, May 16 (Reuters) - China Resources Gas Group Ltd (CR Gas) agreed to buy AEI China Gas Ltd for $238 million from a group of investors including Goldman Sachs to enlarge its share of the country's booming natural gas distribution market.

Big state companies, confident that domestic gas prices will rise as China liberalises the sector, are buying up local distributors and raising fresh capital - and making natural gas the hottest prospect for energy investment in the country.

China is pushing energy price reforms and spending billions of dollars on gas imports and infrastructure to cut the use of coal, which it relies on for more than 70 percent of its energy but has also made it the world leader in mine accidents and greenhouse emissions, and among the worst for air pollution.

CR Gas, controlled by sprawling state conglomerate China Resources Holdings, said it would buy the entire issued share capital of AEI China, which operates 28 city gas projects, eight gas stations and four gas pipelines in 11 Chinese provinces, from AEI Asia Ltd.

"The acquisition is part of the on-going expansion strategy of the group, with the aim of becoming the market leader in the downstream city gas industry in the foreseeable future," CR Gas Executive Director Ken Ong said in a statement, which didn't give details of the seller.

Ken Ong, chief financial officer of CR Gas, told an analysts briefing that AEI China was controlled by Goldman, Government of Singapore Investment Corp and an energy fund. The seller, which has been operating in China for eight years, was advised by Morgan Stanley on the deal.

Shares of CR Gas, which currently has 73 city gas projects in 16 provinces, edged down 0.14 percent to HK$14.58 after hitting a high of HK$15.12. The Hang Seng Index slumped 3.19 percent.

"The deal is value accretive for CR Gas," Ong said, echoing the view of some industry analysts.

CR Gas' acquisition of AEI China Gas implies over 14 times the target company's 2012 forecast earnings of 106 million yuan ($16.78 million), compared with CR shares' historical price/earnings ratio of more than 20 times, Ong added.

STATE FORAY

CR Gas, which has just taken private smaller rival Zhengzhou Gas, has said it had earmarked HK$15 billion ($1.93 billion) for acquisitions in the 2011-2015 period.

Ong said CR Gas aimed to spend up to $2 billion, including the $238 million used for acquiring AEI China, to boost its sales by 5 billion cubic metres by 2015.

State oil giants China Petroleum & Chemical Corp (Sinopec) and PetroChina Co are also swooping in on the sector, threatening to squeeze out non-state companies such as China Gas Holdings Ltd.

Sinopec and ENN Energy Holdings Ltd recently proposed an offer of $2.2 billion for China Gas, and a bidding war may be brewing with state-run conglomerate Beijing Enterprises Group Co Ltd, parent of Hong Kong-listed distributor Beijing Enterprises Holding Ltd.

AEI China has substantial earnings upside potential in light of the acquisition that will create synergies with CR Gas, analysts say.

CR Gas already has city gas projects in 10 of the 11 provinces AEI China operates, Ong said, adding that industrial clients account for 85 percent of AEI China's annual sales of 350 million cubic metres.

AEI China booked a net profit of 83 million yuan in 2011, more than doubling 2010's 38 million yuan, CR Gas said. It had an unaudited net asset value of 1.66 billion yuan at the end of last year.