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August 2015
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Investing In Cuba – A Tantalizing And Troublesome Proposition

Investing In Cuba: A Tantalizing And Troublesome Proposition
By Daniel Sachs

HOUSTON – For an estrangement that lasted 54 years, the resumption of
diplomatic relations between the US and Cuba happened rather quickly.
Just seven months elapsed between Barack Obama’s December announcement
of a change in US policy and the opening of a US embassy in Havana last
month. Of course, the two countries won’t enjoy anything resembling
normal relations until the US Congress repeals the trade embargo against
Cuba. That niggling detail continues to temper the ambitions of many US
companies hoping to capitalize on a new market. But while major
investment opportunities for US businesses will remain off the table for
the time being, warming relations have produced some tangible, if
limited, opportunities for companies looking to enter what was until
very recently a closed economy for Americans.

Several sectors could see immediate benefits from the Obama
administration’s revisions to the Cuban Assets Control Regulations and
Export Administration Regulations. One potential boon sector is travel.
Although general tourism for US citizens remains prohibited under the
embargo, Americans can now book online travel directly with US airlines
and travel agents if traveling to the Island for one of a number of
authorized reasons. This replaces the previous system of making bookings
through government-authorized agencies. Cheapair now offers charter
flights from Orlando and New York to Havana, allowing travelers to book
travel online for the first time. Online accommodation rental firm
Airbnb has moved into the Cuban market, though its opportunities are
likely to be limited in the immediate term—95% of Cubans do not have
access to the internet to advertise their properties, and although they
are now technically allowed to buy and sell property, the vast majority
of Cubans still do not own their own houses. Carnival Cruises announced
earlier in July that it will operate a service to Cuba in 2016, though
its passengers will be volunteers and authorized educational visitors as
opposed to tourists.

The US banking sector also stands to gain from the easing of sanctions.
The April removal of Cuba from the US State Sponsors of Terrorism list
built on the easing of the Cuban Assets Control Regulations and Export
Administration Regulations and allows for the limited involvement of US
banks in the Cuban market. US financial institutions can enroll
merchants and process credit and debit card transactions for
travel-related and certain other transactions in Cuba. Although
Americans traveling to Cuba are now allowed to use US credit and debit
cards, the country’s infrastructure will take a while to upgrade to the
point that local acceptance of such transactions becomes widespread
across the island. In addition, a US bank is now permitted to establish
a correspondent account at a Cuban bank or foreign bank located in Cuba
to facilitate the processing of authorized transactions.

The easing of sanctions also has implications for US telecommunications
firms looking to invest in Cuba, with the sale of some specific personal
communications equipment and services now permitted. Additionally, US
companies are permitted to work on projects to improve Cuba’s outdated
internet and telecom infrastructure. In February, New Jersey-based IDT
Corp announced that it had reached an agreement with Empresa de
Telecomunicaciones de Cuba (ETECSA), the island’s national telecom
provider, to exchange international long-distance traffic (previously
banned). IDT will also be able to sell its interconnection service to
other US carriers that provide service to Cuba. However, opportunities
are limited by the lack of internet penetration, and the cost remains
prohibitive despite a recent discount in state-determined rates. It is
also unclear how committed the government is to the liberalization of
the sector given political sensitivities surrounding greater internet
access. Netflix recently announced that it was entering the Cuban
market, garnering much fanfare. However, this move seems nothing more
than symbolic at this stage—most internet service in Cuba is dial-up and
therefore only good for email and basic web surfing.

Other industries have had what was until recently a largely aspirational
interest in Cuba piqued by the developments. These include agribusiness,
construction and pharmaceuticals. These sectors will likely have to wait
until the lifting of the embargo to make serious inroads. The much
touted USD 900 million Mariel Free Trade Zone remains inoperative for
the time being.

American investors will not be able to access wider opportunities in
Cuba unless Congress repeals the Helms Burton act that strengthened the
embargo in 1996. Repeal seems unlikely in the next two to three years,
largely as a result of domestic political opposition from a
Republican-led Congress. Key figures within the party heavily opposed
the recent rapprochement. The upcoming presidential election is likely
to further entrench these positions, particularly as Republicans look to
avoid unsettling the Cuban American population in Florida—a key
electoral demographic in a pivotal battleground state.

Longer-term prospects are far more positive. Most polls show a strong
majority of Americans, even within the Cuban-American population,
support not only the restoration of diplomatic ties but also the lifting
of the embargo. Many younger Cuban Americans born in the US do not have
the same animosity for the Castros as their parents and see the embargo
largely as a geopolitical relic in need of revision. Obama’s actions
appear to have set in motion an unstoppable momentum offset only by time.

However, investors should not allow their anticipation of opportunities
in Cuba to overshadow the considerable challenges that will likely
persist much longer than the embargo. Cuba’s infrastructure is
deficient, even by the standards of it’s Caribbean neighbors. Roads are
in a state of constant disrepair and power outages are common. Banking
infrastructure is extremely weak, with a dearth of ATMs, particularly
outside of Havana, while the vast majority of local businesses do not
have the capability to handle US credit and debit cards. Public-sector
corruption is rampant, a particular problem given that most investment
opportunities are only available through a local joint venture with a
state-owned entity.

A lack of judicial independence represents another red flag for
potential investors. In an environment that is rife with corruption
risk, this is a particular concern—last year a Canadian automotive
executive and two associates were sentenced by a Cuban court in 2014 to
15 years in prison on corruption-related charges. The individual’s
lawyers argued that he had been denied access to due process and he was
later released. Nonetheless, the case highlights the litany of concerns
for investors, including contractual risks, rampant corruption and state
interference. Outstanding property claims for Cuban Americans also bring
about significant property rights concerns for investors in the longer term.

Opportunity seekers in Cuba—whether seeking to capitalize on the
immediate opportunities generated by the easing of sanctions or those
eyeing longer-term opportunities—must carefully plan their entry into
the market. Cuba will remain a high-risk market for the foreseeable
future, and any successful venture will require astute risk mitigation
measures. A number of leading multinationals from banking giants to
major agribusiness and food companies have created Cuba strategy teams
and are even involved in lobbying Congress to ease trade restrictions.
Some are consulting their counterparts from Europe, Canada and Latin
America who have long had a market presence on the island. They are also
traveling to Cuba on trade missions to cultivate relationships with key
business figures and politicians and better understand the investment
opportunities. In April, New York Governor Andrew Cuomo led a trade
delegation to Havana that included companies such as JetBlue, MasterCard
and Pfizer.

Such efforts can help facilitate entry in a new market, but they are no
substitute for detailed assessments of key local stakeholders. By
developing power maps of relevant government and state-owned
enterprises, companies can gain better insight into individuals’
connections and their capability to influence proposed
investments—positively or negatively. Similarly, investors should carry
out due diligence of potential local partners, including executives in
state-owned entities; preferably conducted by well-placed advisors with
extensive experience conducting investigations in the territory.

These kinds of investigations can help inform a broader assessment of
the political and operational threats to a potential investment. Such
reviews often include detailed scenario planning, including an
assessment of the likely implications of different political
eventualities for the investment opportunities. It is this kind of
planning that helps companies fully appreciate the risk-reward potential
in a challenging new market.

Of course, so long as the embargo remains in place, any pre-market entry
planning must involve attorneys who can navigate the complexities of the
trade embargo prohibitions and help avoid violations. Many major US law
firms are now hiring Cuba expert lawyers, and some Miami-based firms are
operating full domestic Cuba practices. A number of international firms
who have long had a presence in Havana are also capitalizing on the
growing demand.

They and other Cuba watchers recognize that regardless of the pace with
which US restrictions recede, Cuba will remain a difficult environment
in which to do business. And anyone looking to set up shop there will
surely need help.

Source: Investing In Cuba: A Tantalizing And Troublesome Proposition –

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