The Johnny Depp of Closed-End Funds Talks CUBA (part 2)

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Closed-end fund guru Tom Herzfeld discusses Cuba and his most popular fund, the Herzfeld Caribbean Basin Fund (NASDAQ: CUBA).

[Continued from part 1]

Nick Slepko:  Tell me more about the cruise lines and their relationship with the Caribbean and Cuba in particular.

Tom Herzfeld:  The cruise lines don’t talk about Cuba even though it’s a major factor in their business plans…One interesting bit of history is that Costa did have ports of call in Cuba, but ended that program when they were acquired by Carnival (NYSE: CCL).

Still, if you look at some of our largest positions hitting new highs you’ll see the Cuba play in action.  For instance, Carnival is hitting a new high this week and that’s the type of Caribbean company we are interested in.  In fact, about half of Royal Caribbean’s (NYSE: RCL) business comes from the Caribbean.  These are companies that would really benefit from the end of the embargo.  When people take a cruise now they either go to the Eastern Caribbean or the Western Caribbean, but when the embargo lifts you’ll get people wanting to take cruises to Cuba in addition to combining Cuba with their visits to the eastern or western part of the region.

Carnival and Royal Caribbean are the kind of stocks we want to hold especially once they can go to Cuba. But these are also companies that are thriving Caribbean businesses even without major trade changes in Cuba.

Slepko: What can investors get from investing in the Fund that they can’t get from just investing in the sixty-some publicly-traded stocks in the Fund?

Herzfeld: Well, for most of the period of the Fund, they could have just picked up our annual report and bought the stocks.  That’s true of all mutual funds.  Why invest in any of the great – not to say that I’m great – why would you buy any top-rated mutual fund if you could just get the report and buy the stocks? I’ve always found it interesting that the stock market is an area where amateurs try to compete with professionals. If they can beat our track record, I’m all for it. But the key to being an effective fund manager is knowing when to buy, sell and hold, not merely knowing which companies to invest in.

And it’s worth noting that some of our positions in our portfolio cannot be acquired by individual investors at this time.

More recently, we have changed the investment strategy.  As I said, originally we invested in companies that we believed would do well even if there was no economic or political change in Cuba.  And though that’s still important in evaluating many of the companies in the fund, in the last couple of years (and to a larger extent this year), we started investing in more speculative companies that may not do well now, but we feel are stronger Cuba plays.  Some of those investments have been private investments.  For instance, the Miami-based Cuba Business Development Group, in which we have a private placement, is doing business now in the industries permitted under the embargo. Through two of its subsidiaries, they own licenses granted by the US Department of Commerce and the Office of Foreign Assets Control regarding dealings with Cuba. 

In addition to the Cuba Business Development Group, we have three other investments now that are totally related to Cuba.  It started in 1995 with buying the 1977 Republic of Cuba bonds on the NYSE, which were subsequently delisted and subject to transfer restrictions.  Similarly, we have a position in the Cuban Electric Company, which has an OFAC license which spells out the limitations on its transferability.

Over the last sixteen years, we’ve had at least one or two meetings a month with Cuban-American businessmen and other companies with plans for economic development in a Free Cuba.  We’ve been working with them on plans to invest, and I would think we have an edge on that market and that group of investors.

The Cuba Business Development Group is a highly speculative investment for us (and highly-speculative investments only represent a small proportion of our assets).  The founder Hugo Cancio is the son of a prominent musician in Cuba – and he himself is a musician (though he is so talented that he has a great future in anything he would choose to do in the US or Cuba).  The Group’s main business is an affiliated company Fuego Entertainment (which the Fund also owns).

Of course, both [the Group and Fuego] are penny stocks, but that’s the nature of what is available now. If you want to be on the cutting edge of Cuba, you have to be in very speculative investments. Cancio does concerts and promotes records.  He’s signed many Cuban artists and rights to their music.  He travels regularly to Cuba and is well-regarded on both sides of the Strait.  He’s also a sophisticated businessman that understands the stock market – he was able to create public offerings for his companies.  Someone who understands the markets and is also going to be on the ground when the embargo lifts is an interesting combination.  Plus, he’s not political.

There are some very prominent Cuban-American businessmen in Miami that will not touch anything Cuba-related now.  We’ve had long talks with them over the years with a view towards formal relationships when the time comes.

From the inception of the Fund, the Herzfeld/CUBA division of Thomas J. Herzfeld Advisors has retained outside consultants to advise us on developments in the Caribbean and future opportunities in Cuba – and I would not be surprised if some of them occupied important positions in a Free Cuba.

While most of Herzfeld Advisors’ consulting is in the area of closed-end funds, we also have a proposal out with an automotive firm to help them develop a business plan to conduct business in Free Cuba. What I’m hoping is that our consulting relationships will be beneficial not only to the consulting client, but also to the management of the Herzfeld Caribbean Basin Fund.

Slepko: Some substantial publicly traded companies are already in Cuba, like Copa Airlines (NYSE: CPA). Is there a particular reason you only have Copa in your airline holdings?  What about JetBlue (NASDAQ: JBLU), which has extensive tourism and other operations in the Dominican Republic, Puerto Rico, and Saint Lucia and are super aggressive in the region?  Is there a reason they aren’t in your mix? 

Herzfeld: Some of the major US airlines would be a natural, but what percent of the business would be Cuba is the problem.  On the other hand, Copa is flying regularly to Cuba, so there would likely be a greater impact in holding Copa rather than JetBlue.  As for JetBlue, I agree with you they will be an important player bearing in mind they may lose some of their other business for travelers who will opt for Cuba instead of their other Caribbean destinations.

Slepko:  Well, JetBlue with its $5 billion in revenue is just as involved in the Caribbean as $2 billion Copa which like JetBlue splits its activities between the islands and other parts of mainland Americas.  Plus, JetBlue (which I just think is a great experience – for an airline) is beloved by Warren Buffett.  What’s your reservation, or what is the criteria you are using?

Herzfeld: The thing is that Copa is a good Caribbean play with a good Cuba punch.  As for JetBlue, what percentage of their business would come from Cuba if the embargo is lifted?  I think they’ll get a boost in revenue, but the Latin market is growing pretty fast and Copa is right in that area of growth.  I like JetBlue – I fly it myself when my own jet is out of service – just kidding, no jets. I’m more of a boat person (and I even convinced my wife that we needed a yacht to go to Cuba).

[Continued in part 3]

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