Here’s a Glimpse into the Future of U.S. Private Investment in Cuba

Here's a Glimpse into the Future of U.S. Private Investment in Cuba
Mar 13, 2015

As the relationship between the United States and Cuba evolves, so does
the potential for U.S. investment in the island nation. Dan Loney, host
of the Knowledge@Wharton show on Wharton Business Radio on SiriusXM
channel 111 recently spoke on the topic with CNBC's chief international
correspondent, Michelle Caruso-Cabrera, and Tom Herzfeld, an investment
professional who has been sizing up the early-stage possibilities and
has plans under way to invest heavily in Cuba's future.

Herzfeld and Caruso-Cabrera will also be on hand on April 1 when
Knowledge@Wharton, Wharton's Lauder Institute and Momentum Event Group
host the Cuba Opportunity Summit at the NASDAQ MarketSite in New York.

You can listen to the interview with Caruso-Cabrera and Herzfeld using
the player above. An edited transcript of the conversation appears below.

Dan Loney: Michelle, let's talk about Cuba and the importance it has to you.

Michelle Caruso-Cabrera: My mother is a Cuban-American. She's an exile
who came when she was 13 years old, back in the early 1960s. And so,
I've always heard a lot about Cuba from her and from her parents. Then,
as [CNBC's] chief international correspondent, it's this island that is
so close to the United States. When you talk to businesspeople, they
think of it as potentially — not politically — a 51st state.… It's
another 11 million people that could be a potential market that is so
close that you don't have to worry so much about transportation and
shipping costs as you would across the ocean.

Dan Loney: [And] Tom Herzfeld, [you've] been sizing up potential
opportunities with companies that will be logical early stage partners
for the Cuban economy.…Your interest in Cuba goes back a couple of
decades. How did it really all come about?

Tom Herzfeld: Well, my field of specialization is closed-end funds. And
closed-end funds, going back to the 1800s, are the way that investors
participated in emerging markets. So, given that we were based in South
Florida, which is immersed in the Cuban-American culture, society and
economy, and we know the Caribbean very well, it seemed that, [since we
have] the combination of being a closed-end fund expert and a
Caribbean/Cuba expert: Why not form a closed-end fund to invest in the
region?

Loney: In one of the articles I was reading about you, you referenced
the old Jaws movie from the 1970s — the scene where Roy Scheider says,
"You're gonna need a bigger boat." Obviously, Cuba is a big opportunity
for a lot of people.

Herzfeld: It's an opportunity not only commercially as an investor, but
to be involved in rebuilding a country is very exciting, especially for
someone like me who's been trading stocks since the 1960s — it gets a
bit tedious. But being involved in agriculture and construction and
transportation, it's so different for us and exciting.

Caruso-Cabrera: What kinds of stocks are in the fund?… The basis of the
fund is the idea that when relations are re-established, or to some
degree we can do more business with Cuba, that the stocks in there would
benefit. So, what are some of those areas?

Herzfeld: Well, let me just preface this if I may. We're in quiet period
at the moment with the publicly traded fund. But we also run money for
private accounts, and now we started an investment partnership to invest
in Cuba. So, I'd like to just say, any of my remarks now have nothing to
do with our publicly traded fund.

But going back over 20 years, we've looked at almost every industry that
we believe would do well once trade resumed with Cuba. And we've
identified hundreds of potential projects, many of which we can invest
in now — that are legally permissible to invest in now. But at the
forefront of the sectors we're looking at are telecommunications,
building materials, construction related materials, tourism,
hospitality, travel services, marine transportation services and
agriculture. Those will be the first slice that we're going to be
investing in.

Caruso-Cabrera: That sounds exciting. Like what? When I go there, I see
people starting restaurants, starting small businesses. Are those the
kind of things that you're talking about?

Herzfeld: I think at the beginning there might be investment in
mom-and-pop businesses. That's actually one of the areas that we can
invest in. But certainly telecommunications — there was just a deal
announced and that's something we're looking at. And construction
materials. Back and forth commerce and aggregates between Florida and
Cuba will be a major industry. Tourism certainly. There is a tremendous
shortage of hotel rooms in Cuba, which will lead you to look at the
cruise lines, because they actually have the most hotel rooms available
that could be put to use immediately. And agriculture is something we
could invest in now. Food is exempt from the embargo.

Loney: What's your gut feeling, Tom, about when this will all probably
get going? Do you think it could be by the end of this year or early
next year?

Herzfeld: I think so, but I've been wrong on that in past.… But it
certainly seems like this is the year that it will happen. You have the
Summit of the Americas coming up next month.

Caruso-Cabrera: That is the deadline that the President was hoping [to
meet] — that when they got to the Summit of the Americas, that's when
they'd be able to say that the embassies were reopened in both
countries, and that they had been able to finally re-establish
diplomatic relations at that point. So, that's why that's such a key event.

Herzfeld: It's interesting because one of the companies I formed 20
years ago — which was a private company, just my family — the name of
the company is the "Summit of the Americas."

Loney: And one of the funds, ironically enough, has the ticker symbol
CUBA, and that showed very strong interest last year. So, obviously the
interest level has really peaked up. And I guess you saw an unbelievable
peak when the President actually made the announcement earlier on.

Herzfeld: Yeah. I can't talk about our public fund. I would love to, but
I can't.

Caruso-Cabrera: Tom … you invest in the Caribbean.… On a personal level,
I'm interested in Cuba, but it seems to me that the "mind print" for
Cuba is larger than any other island in the Caribbean relative to its
size and its population, etc. Why do you think that is?

Herzfeld: Natural resources, the literacy rate, the industry — the
hard-working people. It is the hub of the Caribbean. And once trade is
resumed, I see tremendous growth for the country.

Loney: In terms of Cuba itself, we've heard so many stories about all of
the different things that the country needs. You rattled off earlier a
bunch of different categories, but are there one or two that seem to be
the most important areas for Cuba to focus on?

Herzfeld: Well, look at historically the largest industries — rum,
sugar, tobacco, tourism, mining, fisheries. But I always found it quite
interesting, our office and my home actually [are] right in the Port of
Miami and [have] been for oh, a quarter of a century now. So, as I look
out the window — and this is where many of our investment ideas came
from — I just look at the harbor and the harbor entrance, I look at the
cruise ships, I look at the dredging companies, the ferry boats coming
in and out, the terminals, the cranes. And you just think all of those
are things that are going to be right on the cutting edge of resumption
of trade in Cuba.

Caruso-Cabrera: The United States is clearly trying to make it easier
for you to do business there. That's very clear. Do you think the Cuban
government is going to reciprocate at all? Because a lot of people say
to me, "Oh, great, Cubans will finally have the Internet now." And I say
to them, "Well, Cuba actually could buy Internet equipment from China.
They buy food from China. They buy rice. They buy beans from China. But
they don't buy Internet equipment. Maybe the Cubans don't have Internet
because the Cuban government doesn't want them to have Internet. Just
because we can sell them stuff doesn't mean they want to buy the stuff
from us, right?

Herzfeld: Yeah, I think it's 5% penetration of the [market].

Caruso-Cabrera: Yes, you're right.

Herzfeld: But I think the attitude of the Cuban government is changing.
And their willingness to restore democracy and political freedom and
free trade — I think it's in motion. And so, it's just a question, not
[of] if it's going to happen, but just how fast. And I think we're on a
fast track.

Loney: But it also has to be a mindset from their government as well;
that they realize that they have to make changes in order to be a
country that is involved in trade. Obviously, they are [trading] with a
lot of countries around the globe. But [they won't be able] to increase
that level and make their country a better option for a variety of
different things if they don't do these types of deals with the United
States and other countries around the globe.

Herzfeld: Yes, I agree completely. It will be interesting to see how
they handle the prior-claims issue. That's something we've looked at in
depth.… In all of the countries where prior claims have been initiated,
they one way or another all got settled. So, I think that there actually
is a way to settle the prior claims by exchanging them in part for
shares in an investment fund. And eventually that fund, I think, could
be the first stock listed on the Cuban stock exchange.

Caruso-Cabrera: That would be exciting.

Loney: For those who don't already know, let's talk about what those
"prior claims" are. The exiles who left behind property have claims
against the houses or the businesses that they abandoned. And then,
separate and apart from that, there are hundreds of American companies
and/or individuals who had their property seized in the early 1960s by
the Cuban government. They have a bunch of registered claims at the U.S.
Treasury Department, and they are waiting to negotiate those at some
point with the future government that is willing to negotiate them. And
the question has always been: How do you figure that out? How do you
settle people getting some kind remuneration for what was once theirs?

Herzfeld: By the way, one of my partners actually has one of the largest
prior claims in the country. But I would like to create a fund [to pay]
people who don't want to fight their claims out or wait for an eventual
settlement. If it's approved by the Treasury Department here and the
Cuban government, we'd like to take claims in exchange for shares in our
fund, so that the people who may be giving up their claims of specific
property might have a share in a large pool of claims, which we would
then create businesses and investments in those businesses to develop
the old cement factory or the sugar plantation or something along those
lines.

Caruso-Cabrera: Don't underestimate this. My mother still talks about
going back and getting her grandmother's house. There [are] a lot of
Cuban exiles talking about this.

Loney: I'd think there would be a lot of Cubans thinking about the
opportunity of going back and finding that level of security, but also
retracing their heritage and being able to visit relatives that there
are still there. There's a lot of the personal aspect to this as well.

Herzfeld: Yeah, we hear it constantly, especially in Florida. But as the
generations move on, the interests change. For instance, if we created
an exchange fund for prior claims, it could be done where there were two
classes of stock. Perhaps the older generation might want an income
share, but the next generation might want more of a growth opportunity,
and [a chance to] participate in part of the heritage in Cuba. So, I
find the younger generation has a slightly different view than their
parents did or do.

Caruso-Cabrera: And the polling data certainly shows that. When you talk
to the older generation, many of them tend to be just hard-line
supporters of the embargo, where the younger generations think it's time
to move on and try something different. Tom, have you been to Cuba at
all? I've always wondered: Do you get to go there as part of your investing?

Herzfeld: I personally do not go. My whole team goes, including my
children who work with the firm. They go on humanitarian missions. I
just — it's sensitivity to my friends here in Miami who asked me not to
do it. I decided not to.

Caruso-Cabrera: And that's another issue too.… a lot of the older
generation very much say, "I'm never going back to Cuba until Castro is
gone or the Castros are gone." And they tell their children, "Don't you
go back." And their grandchildren. And it becomes a real [issue] —
within families, it can become really divisive.

Loney: How much of a change will the Cuban government undergo once these
doors are open, with Castro's son running the operation, running the
country? Or do we really need to see a name other than "Castro" running
the government in Cuba to really effect all the types of change that
we're talking about and maybe that we're expecting?

Caruso-Cabrera: Well, certainly the way the embargo law is written, the
Castros have to be gone. But that being said, they've made tiny, tiny
little changes down there that I don't think the government realized the
impact that they would have. They had this announcement a couple years
ago. They said, "OK, before, everybody had to work for the government.
Everybody was a government employee." Every shop, everything [was
controlled by the government]. Now they say, "OK, it's these 200
categories where you can work for yourself instead." And the people who
started those little businesses are doing so well compared to everybody
else, I think the government there has maybe been taken by surprise.
When you lift the lid of economic repression a tiny bit, wow, the impact
is big.

Loney: Obviously, it takes a little while to get that movement going
down to Cuba. But just the ability of small businesses to be able to be
up and running and have an effect on the economy — that's a great way to
start that groundswell of much better public opinion.

Herzfeld: You couldn't be more correct.

Loney: Is it a bit easier with respect to Cuba, in terms of the types of
investments that you could potentially make, because the needs seem to
be so great across the board? It's almost like you can sit back and pick
and choose.

Herzfeld: There are so many opportunities that when we add up how much
we could invest, it's billions.  Twitter But we've got a list now that's
legally permissible. And we're pulling the trigger on that almost as we
speak. And then, there's a deeper list that, as we see perhaps the
embargo being lifted piecemeal, [presents] other opportunities. And
then, of course, full resumption of trade is interesting. The interest
we're getting is from many of the companies we're invested in — public
companies [that] want to go into Cuba. It might be a hotel chain, a
cruise line, a construction company, a ferry company, an airline. And
what we're trying to do is carve out pure Cuba investment so we can
co-invest with those companies.

Loney: Are those primarily U.S. companies or are there companies from
other countries as well?

Herzfeld: Most of the companies we've been speaking to are U.S companies
but we've also spoken recently with Spanish, Canadian companies, a few
companies elsewhere in the Caribbean. Mexico certainly has a high level
of interest in expanding their current trade with Cuba.

Caruso-Cabrera: Now, that's interesting because, besides the United
States, all the countries that you mentioned could previously invest in
Cuba if they wanted to. Do they see something about the change in the
relationship with the United States that gives them more confidence
about being willing to do the investments down there?

Herzfeld: Yeah, they're very timid. We met yesterday with an agency
representing Japan. And they have about $1 billion of unpaid debt from
the 1990s that they're still trying to collect. Yet I know that we had
some very positive discussions with Japanese companies recently. And I
think actually, many of the companies in these countries will use us as
the way to expand and develop new business in Cuba.

Loney: It sounds like you have not only the companies that you were
talking about that have an interest, but a fairly good list of companies
in other areas that, as the embargo opens up, will be ready to invest.

Herzfeld: They're ready. Some of them are investing in our private fund.
And some of them are asking us to co-invest with them and help them
create their businesses. Our team is comprised of some very prominent
Cuban-Americans. And I don't want to elaborate on it at the moment, but
we have the expertise and the relationships to help companies invest in
Cuba.

Caruso-Cabrera: Can you talk about the size in general [of these
investments]? [In] this emerging [market] — I mean, it's not even quite
emerging, right? You wouldn't necessarily go many, many, many billions
of dollars into a single investment? Are we talking about investments in
the single million, less than a million, multimillion [dollar range]?

Herzfeld: I think at the beginning, perhaps 10 or 20 investments of $25
to $50 million.

Caruso-Cabrera: Each?

Herzfeld: Yes. At the beginning.

Caruso-Cabrera: Wow. That would be a huge amount of money going into the
country compared to the former direct investment that they've had for
the last 50 years, which has been almost negligible.

Herzfeld: And then we're targeting, as I said — it's set up in a series,
as a series partnership. So, we think eventually it will be several
billion dollars.

Loney: Once that door opens up, then it's really just going to be a
flood, isn't it?

Herzfeld: Yes. But we don't want to be viewed as carpetbaggers, either,
which I think will be [the mistake] the people coming in behind us may make.

Loney: How tough is that specifically to deal with? Because that is a
perception that you obviously don't want to have attached to you,
attached to your company. Is it a bit of a tricky line to walk?

Herzfeld: Well, the CEO of the Herzfeld Cuba Alternative Division ran a
charitable foundation as well as being a businessman. So, we're very
sensitive to the need for Cuba to rebuild its middle class. And that's
one of the things we're focused on.

Caruso-Cabrera: When you talk about the investments that you're going to
do [in Cuba], because they have a lack of rule of law, there are so many
issues that make it a riskier investment, as is the case with [many]
emerging markets…. Generally, investors demand a higher return from
risky investments. What kind of return, when you talk about those
initial investments, do you think you're going to get, and over what
period of time?

Herzfeld: I think probably I shouldn't tell you what we're trying to
make. But you're correct. We're looking for returns in excess of what
people would make in private ventures and more plain-vanilla
investments. And we want the risk. People who are investing with us are
willing to take the risk. We want that risk.

Loney: Tom, is there also a correlating level of change that you'll see
in the Caribbean in general once the doors to Cuba open up? Once the
U.S. and Cuba really get going full speed, how much will there be an
effect on other nations?

Herzfeld: Well, certainly there will be a shift in tourism — a
geographic shift. But then, in terms of other trade, I think the tide
will lift all of the countries in the region.

Caruso-Cabrera: Tom, when [President Obama's] announcement happened that
morning, did you have any idea? I ask because you have been talking
about investing in Cuba for so long, since I've known you, since I got
to CNBC. When the announcement happened that day, what did you think?

Herzfeld: It was what Dan said. It was, "We need a bigger boat." But I
didn't expect the announcement to go as far as it did.… I didn't think
President Obama would make such a historic change. And it was truly
historic. It will be … one of the key factors in his legacy.

Loney: I was going to say that ends up being a very important piece of
the puzzle, especially for President Obama over [his] last two years.
And you talk about here in the U.S. and on Capitol Hill, all of the
things that the President is trying to get done in his last years. This
obviously becomes one of the important things that he wants to get
completed before the end of his term.

Herzfeld: Yeah. Well, I think it's certainly a very positive
achievement. And I think he will get it done.

Source: A Glimpse into the Future of U.S. Private Investment in Cuba -
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