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

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Michelle Caruso-Cabrera and Tom Herzfeld discuss potential U.S. investment in Cuba.

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.

“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.”–Michelle Caruso-Cabrera

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.

“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.”–Tom Herzfeld

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 [brother] 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. 

There are so many opportunities that when we add up how much we could invest [in Cuba], it’s billions.”–Tom Herzfeld

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.

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