OKLAHOMA CITY—How big does a company need to be these days to compete?

“We talked to a number of the hedge funds who said every one of the sub-$1 billion public companies should not exist,” said Nick Woodruff, managing director at RBC Richardson Barr during an M&A roundtable at the recent DUG Midcontinent Conference. “And, in fact, every one of the sub-$5 billion companies should not exist.”

That’s an exaggeration, he admitted, but scale is the preeminent theme among investors and members of the panel expect a slew of consolidations to take effect in the next two years.

“You need efficiencies from resources and people and capital allocation,” Woodruff said. “We’re seeing consolidation both in the private equity portfolio teams and the publics that we can talk to.”

Since the price downcycle, companies have focused internally to find efficiencies and cost savings, said Stephen Beck, senior director for upstream at Stratas Advisors.

“In the last 12 months, I’d say that we’ve pretty much closed the gap on harvesting that low-hanging fruit of additional efficiencies,” he said. “What it says is, ‘if the easy stuff is done internally, I need to start looking outside,’ and that ushers in a period of additional M&A activity.”

Stratas forecasts capex of about $10 billion in Oklahoma alone during the next 24 months. That takes deep pockets to address, Beck said, and the solution is consolidation.

At issue during the discussion was the $5.5 billion all-stock deal in which Encana Corp. (NYSE: ECA) took over Newfield Exploration Co. (NYSE: NFX). Encana also assumed $2.2 billion in Newfield debt. The panel was unanimous that the transaction was a harbinger of transactions to come.

Jay Salitza, managing director for oil and gas investment banking at KeyBanc Capital Markets, said the deal featured scale and free cash-flow generation.

“What I think people will want to see is the ability to have quality acreage position where you can accelerate if you need to, but at the same time you have the ability to return capital to your shareholders,” he said.

What struck him as odd, however, is how Newfield shareholders have reacted to the deal. From the announcement on Nov. 1 through Dec. 4, the share price fell 26.6% to $17.23.

“That would suggest that Newfield shareholders are not thrilled with the transaction, which, quite honestly, they’re being offered a premium relative to what their valuation was before,” Salitza said.

In the long term, companies will benefit from these consolidations, he said, but in the short term: “the CFO, CEO, board are just going to have to hold on for the ride because it seems like it’s going to be a rough one.”

The consolidations allow small and medium-size companies to accomplish important objectives, Beck said. They allow companies to satisfy investors that they are both living within cash flow and engaging in responsible development. That requires scale. It also enables companies to obtain sophistication in other areas, like chemicals or proppants, that they may not possess.

Does size really drive value?

“In the current world, people are saying yes, that is what drives value,” Salitza said. “They are all very smart transactions so that is probably going to be what you see more of going forward as it relates to those larger transactions. The smaller ones, you’ll probably still see some cash component to it. For the most part, it is companies wanting to continue to enjoy the upside.”

Joseph Markman can be reached at jmarkman@hartenergy.com or @JHMarkman.

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