Cuba's risky market is no basket case

Cuba's risky market is no basket case

By David Stevenson

Published: March 28 2008 16:04 | Last updated: March 28 2008 16:04

Imagine all those well-educated Cubans standing in front of the gates
marked "Capitalist Goldrush Starts Here".

Outside sits an army of hot money investors ready to stampede the
world's 17th largest island. Fidel Castro has stepped down in favour of
brother Raul, with the unstated promise of "liberalisation" at some
future point. But there appears to be a hitch or two. The first is that
Cuba was, and still is, socialist and does not boast an evil stock
market. As hitches go, that is a big one.

The second bigger hitch is that there is not a convincing way of
capturing that investment story in a direct way. There is an American
mutual fund called the Herzfeld Caribbean Basin Fund, (Cuba) which is a
closed-end fund trying to play the Cuban story by investing in stocks of
the Caribbean Basin Countries. It is a nice idea but in reality 65 per
cent of the fund is invested in US stocks, Florida-based stocks in
particular – real estate, infrastructure, media, transport. The problem,
apart from the yo-yoing share price, is that the fund does not invest in
Cuba as that is against the law in the US. There is also a Canadian
company called Leisure Canada, which is active in the hotels and
property sector, but information on trading is a bit thin
(www.leisurecanada.com).

Sherritt International looks more interesting. It is another Canadian
outfit, but boasts a successful mining operation in Cuba and owns a
third of Cuban electric utility Energas. It is an impressive outfit but
it is not a pure Cuba play as it also boasts big assets in Canada,
Madagascar and Spain.

The rest of the very short list of usual suspects includes huge Spanish
and Brazilian outfits that do well out of Cuba (Sol Melia, Repsol,
Altadis and particularly Petrobas) and some unlikely potentials in the
shape of Carnival Corp and Royal Caribbean Cruises, which may apparently
benefit from more cruises to Florida.

With the exception of Sherritt, I cannot say that any of these shares
strike me as an appealing direct play on Cuba, which is a pity because
Cuba is no basket case. It has a "sort of" functioning economy that has
the real potential to turn into an authoritarian social democratic
market state.

Depending on who you talk to, economic growth in Cuba has been chugging
along at between 8 and 12 per cent per annum and private sector
employment has almost tripled since 1981. There is also a fair bit of
resources potential – 59 oil exploration blocks in Cuba's Gulf of Mexico
have been made available to foreign partners and there could be as much
as 5bn barrels of oil in the zone, although no significant discoveries
have been made so far. Cuba also holds vast nickel reserves.

All this should not blind investors to the reality that tourist revenues
have been declining and the economy has been running a trade deficit
that hit $1.1bn in 2005. Cuba also has lots of debt – there is at least
$7.8bn (£3.9bn) active debt (the stuff it is willing to pay) plus a
whole load of non-performing debt it has defaulted on.

Great potential, half-decent economy, but lots of over-powerful
socialists, keen to keep a tight control on foreign currency earnings.
These bureaucrats can easily ruin an investment overnight, although
Cuba's Foreign Investment Act does guarantee the repatriation of profits
in freely convertible currency.

So how do we access this promising but risky story? Step forward my
latest small discovery in wonderful world of adventurous investing,
Ceiba Investments, a Channel Islands-listed offshore fund that has been
flying under the radar for the past few years.

As one investor put it "this is the only credible play if you want to
invest in this space . . . there's simply no other real choice". It is
Barcelona-based but has offices in Cuba, has real, tangible investments
on the ground and boasts investment trust SVM Global and hedge fund
Value Catalyst as investors. It also takes a novel but risky approach –
focusing on large-scale property projects in the business and tourist
sector. Investments include a $36m beach hotel about to start
construction plus Inmobiliaria Monte Barreto. This joint venture owns
the Miramar Trade Centre in Havana, 16 buildings owned in partnership
with the Cuban government. This centre is growing and is expected to hit
150,000 m2 although current book value (at cost) is already $135m. There
is also a ragbag of other interests that include a new office and
apartment block, loan notes to the Cuban Tourist ministry, plus plans
for a hotel in Havana, a beach resort on Cayo Largo and a trendy
magazine titled H.

You are essentially making a three-to-five year bet on Ceiba's
investments – the shares' net-asset value has not moved much in the past
few years primarily because the managers have been in development mode.

These projects have potential (the company already pays out a yield of
just over 6 per cent per annum) but they could be undone overnight by
administrative fiat.

I am also more than a little worried about the relative lack of
diversification – I would be happier seeing maybe five or seven big
investments including housing projects as well as some service companies
with real turnover. Also, there are rumoured to be some global
investment banks readying Cuban investment funds and they could snaffle
up Ceiba's managers, leaving the fund in the lurch.

But the mismatch between the share price (about€1.15) and the flat NAV
(about €0.67) tells you the market believes these property assets are
hugely under-valued. Add the possibility that a future US Democratic
president could start lifting the embargo in 2009 and the certainty that
Ceiba will hit Aim in the not too distant future, and you have a
potentially interesting but risky medium-term bet.

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