Liquidation Arbitrage, Definition

Liquidation arbitrage is a strategy to profit from a company's aquisition or breakup based on research showing that the value of a company's liquidation assets is greater than it's stock value.

The strategy can be highly profitable due to the fact that many businesses own assets that their stock market valuation does not reflect, for example real estate. If a fund manager decides that the value of all the assets of a company are not reflected in the stock price they may decide to buy shares of the company in anticipation that someone will attempt to aquire the company at a price that better represents it's value.

Gordon Gekko from the movie Wall Street was a colorful depiction of a liquidation arbitrageur. In the movie, Gekko wanted to take control of an airline company to profit from it's over funded pension. In the 1980's real life arbitrageurs such as Ivan Boesky and Dennis Levine practiced liquidation arbitrage using insider knowledge as to which companies were going to be aquired.  This strategy is illegal - but liquidation arbitrage is perfectly legal as long as it is based on publicly available information.

Liquidation arbitrageurs can aquire enough shares of a company to prevent a merger,  and take over the company themselves. Such arbitrageurs are also known as corporate raiders. In such hostile takeover situations the assets of the purchased company are often immediately sold off.

See also: Risk Arbitrage, Vulture Capitalist