Cuba Opens Up To Investors

Exploding cigars, poisoned milkshakes and toxic wetsuits – over the years America’s Central Intelligence Agency has tried all sorts of wacky ways to assassinate Fidel Castro. It even bribed his lover to poison him, but at the last minute, she got cold feet.

Fortunately, for Castro all of the schemes were as unsuccessful as they were harebrained.

He also managed to dodge some of the CIA’s other, less fatal plans. One of my favourites is the ploy to lower his standing among the Cuban people by making his beard fall out. Or a bizarre attempt to spray him with hallucinogenic fumes while he was addressing the nation on the radio.

After the failure of these plans, successive American presidents have had to learn to tolerate Castro. Yet while the US may not have been able to shift the man, it determined to make his life as difficult as possible. Ever since he nationalised American business interests in 1962, the US has maintained a strict trade embargo against Cuba.

However, just before Christmas, Barack Obama and Raul Castro (Fidel’s brother) shocked the world. They announced a thaw in relations that would allow for more trade between the two countries. The political significance of the move is huge. It reverses one of the central tenets of US foreign policy over the last half a century.

It’s also a big deal for investors. It will lead to a flood of US money to Cuba and the potential for big profits.

Cuba: America’s new favourite holiday destination

To begin with, the US trade embargo on Cuba was just a policy – one that repeated administrations chose to continue. Many expected the US to change course after the fall of the Soviet Union in 1991, especially as other Western nations began trading with Cuba.

But in 1996, when the Cuban Air Force shot down two planes that were being flown by US-based anti-Castro activists, the US went a step further and enshrined the embargo in law through the Helms Burton Act.

That matters, because it means that Obama has some limits on what he can agree with Raul Castro. With the Republicans controlling both the Senate and Congress, it would be impossible for Obama to overturn the law. Yet using his presidential power of executive decree, he has managed to agree a historic deal with his Cuban counterpart.

The deal allows for US goods to be exported to Cuba – in particular, it covers material for residential construction, agricultural machinery and telecommunications equipment.

Meanwhile US firms will be able to do business with offshore Cuban companies and the limit on remittances to Cuba will be increased from $500 to $2,000 per quarter.

As for the all-important tourists, travel restrictions have also been relaxed. In theory, US law still prohibits general tourism but lots of new visitors will use one of the 12 new visitor categories, such as academic, that have been created.

Make no mistake the deal with have a big impact on the Cuban economy. The measures above may not sound that striking, but they will be a huge change for the country.

Cuba’s economy desperately needs an upgrade

Half a century of embargo starved Cuba of the dollars and technology it would have gained from open relations with the US. Of course, Cuba attempted to counteract the effects of the embargo by courting economic support first from Russia and then from Venezuela.

But while both countries gave generous assistance to Cuba, its economy has remained underdeveloped by regional standards. Indeed, it’s estimated that over the last half a century the embargo cost Cuba $1.1trn.

"An improved relationship with the US could help ease several bottlenecks and unlock rapid growth…."

As a result, Cuba’s economy is not in a good state, with terrible productivity in several sectors. An improved relationship with the US could help ease several bottlenecks and unlock rapid growth. Perhaps the biggest bottleneck is agriculture, where Cuba imports 60% of its food needs. With modern farming technology, Cuba could easily boost agricultural output.

The island’s transport and communication networks are also outdated, which is one reason for the terrible productivity across the economy. In particular, internet penetration of 5% is among the lowest in the world. Energy is another problem. Cuba has long relied on subsidised imports from Russia and Venezuela, but geologists believe it could be home to rich hydrocarbon deposits itself. So far, European firms have been unable to find it but US oil companies may have more success. Finally the increased remittance limit would provide a useful source of hard currency to the indebted island.

Of course there are clearly some challenges. The most obvious is politics. The Cuban-American lobby in the US, which is made up of exiles that fled Castro’s Cuba, is outraged by the deal and promising to try to scupper it. Likewise, there are still some Republicans that worry about the world turning Communist and imagine Cuba to be some sort of threat. On the Cuban side, we have to remember that it’s a one-party state headed up by an 83-year-old. The transition of power, which must happen sometime, could lead to instability.

But while these factors could cause short-term hiccups they won’t be able to derail the overall move towards improved relations.

How we can profit from Cuba’s growth

Increased trade with the US should help boost the Cuban economy over the medium term. However, there’s another element of this deal that should provide quicker returns for investors – American tourists.

We Europeans may like to joke about the stereotypical ‘American abroad’ but they will give a huge boost to Cuba’s already flourishing tourist industry. Until now, Cuba’s hoteliers have been unable to profit from the fact that their island paradise is just 90 miles away from the world’s third-biggest source of tourist spending. Now they can.

Last Friday the US government released the details of the new tourist rules, which took effect immediately. Basically any US company or organisation can now arrange a group trip of Cuba. In theory, they have to fall into one of 12 categories of visitor but the categories are broad and analysts don’t expect them to be rigorously enforced. Moreover the legal stops and checks, which were previously used to dissuade Americans from visiting Cuba, have also been dropped.

The deal also makes it easier for US companies to support tourism. US airlines will now be allowed to offer regularly scheduled flights to Cuba – until now it was just special charters. America’s airlines have been quick to react with United Airlines, Delta Airlines and JetBlue Airways all stating that they are keen to open regular US, Cuba services.

And another boost for Cuba’s tourist industry is that American banks have also been given the right to work with Cuban firms, which means US citizens will be able to use their credit cards in Cuba.

So what should investors be buying?

If Cuba takes off, this fund will be the first to benefit

The initial stockmarket reaction to the deal was upbeat, with the shares of several US-listed firms rising on the news. Florida-centred construction companies and cruise liners all saw their shares get a small boost from the agreement.

The biggest winner though was the Herzfeld Caribbean Basin Fund (Nasdaq:CUBA), which gained 100%.

The fund invests in regional companies that would benefit from a resurgent Cuba. So it owns regional carrier Copa – which readers will know is one of my favourites – and should benefit if there is a tourist boom in Cuba. Other holdings include Royal Caribbean Cruises and regional fizzy drink producer, Coca Cola Femsa, and regional cement producer Cemex.

And while the fund still isn’t permitted to own anything directly in Cuba yet, its founder has promised to start investing directly as soon the rules are relaxed further and he is allowed to.

Cuba’s road to prosperity is likely to be a bumpy one, with plenty of twists and turns along the way. But in the long run, increased trade with the US will boost the economy and this fund is the best way to play it.