How does MatchEvaluator in Regex.Replace work?

A MatchEvaluator is a delegate that takes a Match object and returns a string that should be replaced instead of the match. You can also refer to groups from the match. You can rewrite your code as follows:

string input = "23x * y34x2";
Regex reg = new Regex(@"\d(?=[a-z])|[a-z](?=\d)");
string result = reg.Replace(input, delegate(Match m) {
    return m.Value + " * ";
});

To give an example of how this works, the first time the delegate is called, Match parameter will be a match on the string "3". The delegate in this case is defined to return the match itself as a string concatenated with " * ". So the first "3" is replaced with "3 * ".

The process continues in this way, with delegate being called once for each match in the original string.