Puerto Rico positions itself as an investment play

An amazing pair of tax incentives has set this special region up as an especially lucrative destination for wealthy US investors.

By StreetAuthority May 13, 2014 4:22PM
San Juan, Puerto Rico
© bdnegin/ iStock / 360/Getty ImagesBy Jimmy Butts

It's something that hasn't been done in almost two decades.

In an attempt to ease the economic hemorrhaging from a recession that's lasted nearly eight years, Puerto Rico passed a balanced budget earlier this month.

The rare feat was a sign of hope for the U.S. protectorate as it attempts to whittle down its $70 billion in public debt, lower an unemployment rate hovering near 15 percent and stave off a "brain drain" that's seen over 450,000 people flee the tiny Caribbean island.

What does this all mean?

Simply put, it means Puerto Rico is setting up to be an incredible investment opportunity and tax haven for U.S. citizens.

Let me explain.

Hedge fund billionaire John Paulson -- known for his $15 billion bet against subprime mortgages as the financial crisis hit -- says Puerto Rico could be the next "Singapore of the Caribbean." His firm, Paulson & Co., is investing $260 million this year in two upscale beachfront hotels in San Juan, the commonwealth's capital. All told, Paulson is expected to invest up to $1 billion in Puerto Rico by the end of 2015.

Puerto Rico is making all the right moves to spur economic growth by attracting wealthy investors and businesses. Two recent moves in particular are meant to entice outside investors -- namely, wealthy U.S. investors.

The first, known as the Individual Investors Act (Act 22), states that new residents of Puerto Rico are completely exempt from taxation on their capital gains, dividends and interest income.

The second, known as the Export Services Act (Act 20), levies a top 4% tax rate on earnings from businesses that perform services like consulting, asset management, computer programming, research and development for clients outside of the island -- as long as the company is based in Puerto Rico.

Now to get an understanding of why these two tax laws are so attractive to U.S. investors, one must understand that Americans couldn't typically take advantage of these sorts of situations. If a U.S. citizen moves abroad, they are still taxed on their income -- no matter where they earn it and no matter how long they plan to live abroad.

So unless you were willing to go through the lengthy, expensive and arduous process of setting up a foreign trust or renouncing your U.S. citizenship, the rule of thumb has always been that no matter where you live or where you earn your money, you still have to pay taxes on that income... until now.

Because Puerto Rico is not quite a state and not quite a foreign country, citizens of Puerto Rico pay taxes to the Puerto Rican government, not the U.S. government -- yet they are still considered U.S. citizens. Combine this with the new tax incentives, and you have yourself a unique situation to legally lower some of the U.S. tax burdens -- while still retaining your American passport.

It's clear that these incredible tax incentives should invite a flood of capital and economic growth as wealthy U.S.-based investors catch on -- and when you can get in on the ground floor with some of America's wealthiest investors, you have the potential to make enormous gains. So what's the best way to invest in Puerto Rico?

One way I'll be looking to invest is in companies that relocate to Puerto Rico to take advantage of the huge tax incentives. Paying less tax means businesses can hang onto more of their revenue -- which means more money to pass along to their shareholders.

One company that's looking to invest more in its operations in Puerto Rico is Arizona-based Honeywell Aerospace (HON), a diversified technology and manufacturing company. Puerto Rico is already home to Honeywell's aerospace unit, which produces a wide variety of aviation products like turbine propulsion engines, navigation, radar and surveillance systems and aircraft lighting.

A different investment that's more of a "pure play" as Puerto Rico gets its feet back under it is Banco Popular (BPOP), which provides a range of retail and commercial banking products and services primarily to customers in Puerto Rico and the United States.

The company is looking to divest a majority of its U.S. branches to boost profitability and strengthen its ability to repay a government bailout of $935 million. To help reduce operating expenses, the bank will be focusing its U.S. retail footprint in New York, New Jersey and Florida. It will also be consolidating its operation centers, bringing about 200 jobs back to Puerto Rico.

The effects of management's adjustments to cut costs and increase revenue can be seen in the bank's most recent quarter: Banco Popular posted net income of $86.4 million, up from a loss of $120 million a year ago.

BPOP sports dirt-cheap valuation metrics, too. Its price-to-book ratio is currently 0.7, meaning the stock is trading for less than the value of the assets on its balance sheet. Banco Popular's price-to-earnings (P/E) ratio is a ridiculously low 3.9, with a forward P/E of 10.6.

Risks to consider: While Puerto Rico is making the right steps to recovery, concerns about its economy remain. After all, eight years of turmoil can't be resolved in a few months. Banco Popular is definitely not for those who are risk-averse. While it is showing improvements, it is wise to tread carefully.

Action to take:
Investing in Puerto Rico isn't for faint-hearted investors -- but once the ball gets rolling and the "Singapore of the Caribbean" begins to emerge, Banco Popular will likely be at the forefront, serving as an engine of growth. As businesses, entrepreneurs and capital flock to Puerto Rico, Banco Popular, the dominant player, will likely be able to profit from the substantial increase in banking activity and investments that come along with them.

Jimmy Butts does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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1Comment
May 14, 2014 9:42AM
avatar
What a great tax dodge for investment banks...
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