China Mengniu Dairy (2319.HK) has held talks about buying China's largest raw milk producer, KKR & Co-backed China Modern Dairy Holdings Ltd (1117.HK), a media report said on Tuesday.

KKR (KKR.N) and Mengniu Dairy's largest shareholder, China's state-owned COFCO Corp, have been involved in the talks, Bloomberg said, citing people with knowledge with the matter.

Officials from China Modern Dairy and Mengniu, the country's top dairy products producer, were not available for comment. KKR declined to comment.

Shares in China Modern Dairy extended gains to trade up as much as 18 percent on Tuesday, hitting HK$2.37, its highest since March, and valuing the company at about $1.5 billion, according to Thomson Reuters data.

The shares stood at HK$2.23 as at 0614 GMT, up nearly 11 percent and outperforming a 0.6 percent gain in the benchmark Hang Seng Index .HSI. Shares of Mengniu were down 0.2 percent.

Modern Dairy, which supplies most of its milk to Mengniu Dairy, has said it aims to have 30 farms by 2015, each with 10,000-40,000 cows. A deal would give Mengniu more control over its milk supply.

China's dairy market remains in its infancy, with consumption of dairy products growing at an annual compound rate of 20 percent, a stark contrast to U.S. and European markets where demand has been shrinking in the past decade.

Demand for high quality milk is increasing rapidly, especially in the wake of a massive industry scandal in 2008, when melamine-tainted milk powder was blamed for the deaths of at least six children.

The scandal hit major dairy product makers including Mengniu, Bright Dairy & Food Co Ltd (600597.SS) and Inner Mongolia Yili Industrial Group Co Ltd (600887.SS).

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