1. Friendly Mergers
This is where two companies have agreed to merge with each other.
An example would be Burlington Northern Santa Fe (BNSF) railway's agreeing to be acquired by Berkshire for $100 a share.
This presents an arbitrage opportunity in that BNSF's stock price will trade slightly below Berkshire's offer price, right up until the day the deal closes.
These kinds of deals are plentiful.
2. Hostile Takeovers
This is where Company A wants to buy Company B, but the management of Company B doesn't want to sell.
So Company A decides to make a hostile bid for Company B.
This means that Company A is gong to try to buy a controlling interest by taking its offer directly to Company B's shareholders.
An example of a hostile takeover would be Kraft Foods Inc.'s hostile takeover bid for Cadbury plc.
This kind of corporate battle can get real ugly, but it can offer lots of opportunity to make a fortune.
3. Corporate Self-Tender Offers
Sometimes companies will buy back their own shares
- by purchasing them in the stock market, and
- sometimes they do it by making a public tender offer directly to their shareholders.
An example of this would be Maxgen's tender offer for 6 million of its own shares.
You can arbitrage on these self-tenders.
Special Situations Category
This is where a company decides to sell its assets and pay out the proceeds to its shareholders.
Sometimes an arbitrage opportunity arises when the price of the company's shares are less than what the liquidated payout will be.
An example of this would be when the real estate trust MGI Properties liquidated its portfolio of properties at a higher value than its shares were selling for.
Conglomerates often own a collection of a lot of mediocre businesses mixed in with one or two great ones.
The mediocre businesses dominate the stock market's valuation of the business as a whole.
To realize the true value of the great businesses, the company will sometimes spin them off to the shareholders.
It is possible to buy a great business at a bargain price by buying the conglomerate's shares before the spin-off, as when Dun & Bradstreet spun off Moody's Investors Service.
Spin-offs come under the category of special situations.
Stubs are a special class of financial instrument that represent an interest in some asset of the company.
They can also be a minority interest in a company that has been taken private.
An arbitrage opportunity arises when the current stub price is lower than the asset value that the stub represents and there is some plan in place to realize the stub's full value.
Warren's earliest arbitrage play involved buying shares in a cocoa producer, then trading the shares in for warehouse receipts for actual cocoa, which he then sold.
The warehouse receipts were a kind of stub.
Though they are known under many different names - minority interests, certificates of beneficial interests, certificates of participation, certificates of contingent interests, warehouse receipts, scrip, and liquidation certificates - they still present you with many wonderful opportunities to profit from them.
This is a huge area of special situations that offer some very interesting arbitrage-like opportunities.
A most notable being ServiceMaster's conversion from a corporation to a master limited partnership and Tenneco Inc.'s conversion from a corporation into a royalty trust.