A net operating loss (NOL) can be carried forward to offset future income for the purposes of calculating a company's taxes. The market doesn't always properly recognize these assets (which are often not on company balance sheets), as we've seen a couple of examples where investors were offered great discounts on NOLs. A current example may be ADPT Corp. (ADPT), formerly known as Adaptec.
ADPT trades for $350 million, despite net current assets of $380 million. In addition, the company has over $50 million of tax assets (due to NOLs) that it can carry forward.
Unfortunately, the company is currently burning cash; however, new management has been shrinking the business, selling off patents and assets to realize shareholder value. (For more on this, see this article at the Motley Fool.)
But with almost no operations now, the company cannot use its NOLs as it currently stands, leaving it with two options. It can sell the company to someone who can utilize the assets, or it can buy a profitable company in the same business line and apply the NOLs to the new business.
In the former case, the gains realized are immediate and can benefit shareholders with little risk. Unfortunately, management appears to have decided to pursue* the latter option, which spreads the gains out over time (in the form of reduced taxes owing) and subjects the investor to operating risk (i.e. if business is not so good, the gains may never be realized!) Likely contributing to management's decision in this regard is that there are legal restrictions on the amount of NOLs that an acquiring company can apply (to avoid having successful companies buy failed companies simply for their NOLs).
ADPT trades at a discount to cash less liabilities, and has a bunch of NOLs as well. But this is no ordinary situation for investors looking to capitalize on these NOLs; in order to capture them, management appears intent on spending the cash, which would otherwise act as a margin of safety. As a result, the downside risk to this stock is not limited despite the upside potential.
* From the company's latest 10-Q: "Going forward, our business is expected to consist of capital redeployment and identification of new, profitable business operations in which we can utilize our existing working capital and maximize the use of our net operating losses"