Should You Revolutionize Your Portfolio By Investing in Cuba?

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NEW YORK (MainStreet) -- Cuba, with its longtime trade embargo and travel restrictions, clearly has been the furthest thing from a hotbed of economic activity for decades. But investors hoping all that will change amid eased political relations with the U.S. should be cautious. 

“I don’t mean to be flippant, but [Americans] should be leaving their money in their U.S. bank,” said John S. Kavulich, president of the U.S.-Cuba Trade and Economic Council, Inc. in New York. 

Last week's flag-raising ceremony at the recently re-opened American embassy in Havana is garnering plenty of media coverage and anticipation, but Kavulich downplayed Cuba’s potential as a hub for commerce and conspicuous consumption.

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“Cuba is not Dubai 93 miles southwest of Key West, Florida,” he said. “There are not 11 million people ready to buy a latte at Starbucks, buy a Big Mac or stay in the Marriott.”

That said, the buzz around the island could usher in expansive growth in specific sectors. Should the U.S. Department of the Treasury’s Office of Foreign Assets Control implement its expected changes, U.S. visitors to Cuba will triple, from 500,000 annually to 1.5 million. On a small island, that can generate a significant economic impact.

“Now is the time for discovery, due diligence, and imagination -- to locate projects and partners, to position oneself for the tremendous, once-in-a-lifetime investment opportunities that will open up shortly,” said Richard Feinberg, a nonresident senior fellow in the Latin American Initiative at Brookings and an international political economy professor at UC San Diego. “But it’s not a market for the timid and risk averse.”

With those caveats, there are areas to pinpoint.

“Interesting opportunities for joint ventures will emerge in badly needed infrastructure, in roads, ports, power generation and distribution,” Feinberg said. “More gradually in agriculture and pharmaceuticals. And, of course, tourism.”

The bread-and-butter option to trade on Cuba is the Herzfeld Caribbean Basin Fund , a closed-end fund listed on the Nasdaq comprised of 60 securities. Because there are a limited number of shares, the per-share price can shoot up parabolically as demand grows. As of June 30, the fund only had $40.9 million in assets.

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There may be ample opportunity for growth: CUBA is up just 52.17% in total since its 1994 launch, and with all eyes on the island and opportunities, it could be set for more of an uptick. In fact it's up 31.94% since December 16, 2014, the day before Obama’s announcement about updates between the nations.

The fund is comprised of the following plays in a basket of companies that represents a speculative play at the rise of Cuba:

  • Copa Holdings : 8.8% of assets (major airline serving Latin America that could benefit from bump up in flights to Havana)
  • MasTec  : 6.0% (infrastructure construction)
  • Seaboard  : 5.4% (shipper and pork and poultry seller)
  • Lennar  : 5.3% (homebuilder)
  • Royal Caribbean Cruises  : 4.9% (tourism play)
  • Norwegian Cruise Line Holdings  4.5% (tourism play)

Even naysayer Kavulich spoke of the significance of Secretary of State John Kerry's appearance in Cuba on this investment.

"When that flag raises at the U.S. embassy in Havana, there will be some movement with Herzfeld," he said.

Norwegian CEO Frank Del Rio in particular expects huge growth for his company surrounding the Cuba intrigue.  

"Florida and Cuba are only 222 miles apart," he told TheStreet's Brian Sozzi in February. "God put that body of land in the right place for the cruise industry. Cuba is exciting for other reasons, too. It's the pent-up demand. It has been 55 years since Fidel Castro took over in 1959...There is no question that tourism will be one of the leading industries for Cuba's comeback into the free enterprise system."

The cruise industry brings it's own infrastructure, to boot, so it doesn't have to rely on the build-up of hotels and conveniences to cash in on a boost in its value. 

But building up the country's infrastructure from roadways to ports is something else the fund has locked in its sights: Martin Marietta Materials , Vulcan Materials  and Cemex  are all in the fund.

Real Estate

Another fund play that historically has required some deft maneuvering to access can point the way for success in Cuba investments: CEIBA Investments Ltd. , a closed-end investment fund formerly listed on the Channel Island Stock Exchange that is dedicated to Cuban real estate, specifically of the commercial and tourism variety.

There's a catch, though: Americans can only buy international security shares for companies (and funds with companies) that do business in Cuba if the majority of the company's revenues don't come from the Cuban portion of their enterprises.

But it's possible for the individual American investor to pick and choose individual companies to get in on the Cuba play without investing in the fund. CEIBA has been a shareholder in a joint hotel venture managed by Meliá Hotels International S.A., a Spanish hospitality company traded on the Madrid Stock Exchange that derives most of its income outside of Cuba.

There's a definite shortage of hotel rooms on the island, and with Meliá representing a significant lodging play -- from Meliá Cohiba on the Havana waterfront to Meliá Las Dunas, a five-star, all-inclusive beachfront resort in Cayo Santa María -- the company is primed for expansion amid Cuban travel fervor. This makes it a smart bet for American investors looking to get some international exposure to this emerging market.

Even those skeptical of the brouhaha around Cuba think this is a safe play.

"I am not bullish on Cuba," said Jorge Salazar-Carrillo, professor of economics at Florida International University. "I have seen this picture before with other partial openings, and they have led to increasing unpaid debt."

But he said he would bet on Spanish hotel companies like Meliá.

Another Cuba play is Dundee Corp., a Vancouver-based holding company that purchased international real estate development firm 360 Vox last year. Dundee is traded on Toronto Stock Exchange as DC.A. Dundee's Cuba interests represents under 2% of Dundee's current revenue, according to Guy Chartier, who leads 360 Vox's Cuba division. He currently has a project to build 2,200 residences in Havana -- with condos and villas. It's more than $1 billion worth of real estate on land that is leased but in perpetuity. Along with additional development projects across the island, including towering hotels, the Dundee play on the island is a significant one for growth. 

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Rum & Cigars

It would be impossible to consider Cuban investments without tapping into the products that have been so coveted - tobacco and cigars, said Timothy Ashby, CEO of Pembury Capital, Inc., an investment consultancy specializing in Cuba.

Want in on the Cuban cigar boom? Think British. Imperial Tobacco (IMT), a British tobacco company traded on the London Stock Exchange, has stake in Cuban cigars, owning 50% of Habanos S.A. while the Cuban state company Cubatabaco owns the other half. This current scenario originated from a series of aquisitions In 2000, French-Spanish Altadis purchased a 50% stake in Habanos, and in 2008, Imperial purchased Altadis an swallowed up the Cuba play.

Habanos is the maker of famed Cohiba, Montecristo and Romeo y Julieta cigars, and the company boasted $439 million in 2014 sales without having the U.S. as a direct play. Expectations are high for global sales if the U.S.-Cuba embargo is eliminated; initially Habanos products would make up some 25% of the U.S. premium cigar market before jumping to 70% within a few years - similar to the Habanos control of the market in countries around the world.

Pernod Ricard (RI), traded on the Euronext Paris, worked with Cuban companies in 1993 to create the successful Havana Club International brand, of which it's a 50% owner. Of course, Bacardi has been selling Havana Club to the U.S. market since 2012, when Cuban trademark on the name in the U.S. expired, but Ashby expects the trademark dispute with Bacardi to be resolved in the near future. When the embargo ends, the authentic liquor will be exported to the U.S., the largest market for rum in the world.

Private Sector Cooperatives

The only other option for a U.S. investor is to invest in the rapidly emerging but still small private sector in Cuba, especially the cooperative enterprise sector, according to Havana-based Gregory Biniowsky, a partner at Canadian law firm Gowling, Lafleur, Henderson LLP and founder of the "philanthropic" consulting firm Havanada Consulting.

“It is my belief that U.S. law does not prevent investment in private businesses in Cuba, and Cuban law appears to allow for foreign investment in private cooperatives, although the Cuban regulations still need to be fleshed out more,” he said.

As the dust settles and the rules become more crystalline, Americans can contribute to these emerging cooperatives, ideally by making some direct contact with their management leaders, or having a proxy do so. 

"Cuba is a complex country, with an idiosyncratic political, social and economic terrain," he said. "The country holds enormous potential for economic growth, even under the present socialist regime. But investors need to familiarize themselves with the sui generis characteristics of Cuba to be in an optimal position to take advantage of the inevitable economic boom that will take place in the country."

Ashby says Cuba has a robust tech sector. "It's a smaller version of India," he says.

Entrepreneurs now make up 11% of the Cuban labor force, compared to 3% in 2010, according to Philip Peters, president of the Cuba Research Center. The Cuban government has incentivized foreign investors to steward this growth by instituting a foreign investment law in 2014 that cut investor profit taxes to 15%, half the previous rate, and protecting them from having to pay taxes for eight years. There’s also added security to these private investments. Cuba wants to attract at least $2 billion each year in foreign investment and is willing to incentivize investors to achieve that goal.

“Here's an adventurous prediction,” said Feinberg of UC San Diego. “American firms with claims for nationalized properties will be first in line to exploit these lucrative business opportunities.”

He’s talking about expatriates who left behind property in Cuba or U.S. enterprises that had property seized by the Cuban government in the 1960s.

There is the idea of creating an exchange fund for people who are entitled to claims but don’t want to go through the drawn out process of getting a settlement. Herzfeld has discussed taking claims in exchange for shares of such a fund.These people would give their claims to a particular property but have a share in a pool of claims. The aggregated money could be poured into businesses -- old factories or agricultural enterprises. Thomas Herzfeld, who founded CUBA, declined to comment for this article citing a quiet period of his firm's fiscal year ended June 30. 

Another potentially robust part of the private-sector investment: telecom and internet. Cuba has not joined the 21st century in terms of connectivity. Only a handful of hotels in Havana have WiFi -- which costs about $8 an hour. Companies that can provide growth will be great investments. Internet has about 5% penetration on Cuban households.

Biniowsky notes the many advantages Cuba presents for growth:

-Imminent tourist boom with the eventual lifting of the U.S. travel ban.

-Medium term general economic boom with the eventual lifting of the US economic embargo.

-Best educated population in Latin America (both general education levels and specialized professional class).

-Low levels of political corruption.

-Low levels of violent crime.

-Largest land mass in the Caribbean, with extensive fertile agricultural land and undeveloped beach areas.

-Largest population in the Caribbean.

-Strategic geographic location for transport from Europe and transport emerging from the Panama canal and future Nicaraguan canal.

-Significant pharmaceutical and biotech potential.

-Significant medical services potential (health tourism)

Proceed with Caution

“It’s investment by romance,” said Kavulich about those eager to wade into Cuban investment waters. “People are reacting in an aspirational way – 'Cuba is crumbling it needs everything.’… We’re trying to sober people up.”

Of course, Fidel Castro has announced he wants the U.S. to pay reparations for the economic stagnation wrought on the island in the wake of the embargo. That should give investors pause as to whether this will be the bastion of growth many are expecting or if politics will stifle this ripe economic terrain further.

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