Interestingly enough, investors did not shy away from Arco Platform's (ARCE) IPO, despite the fact that ARCE is a Brazilian company. Brazil, as many may be aware, has been one of the weakest emerging markets as its currency has taken a nose dive this year. Its Q2 GDP came in at a pedestrian 0.2% and the unemployment rate is hovering above 12%. While Brazil, as an "emerging market" economy, is also impacted by trade concerns, much of its issues stem from political turmoil following the impeachment of its president in 2016, and uncertainty surrounding its upcoming elections this October.
With that in mind, it is somewhat surprising that ARCE's 11.1 mln ADS priced at $17.50 which was at the high end of the expected price range of $15.50-$17.50. However, the company's growth has been impressive, its margins are expanding, and it is profitable. The deal also had tier one firms behind it in Goldman Sachs, Morgan Stanley, BofA Merrill Lynch, and Itau.
Also, with the bulk of the trade war headlines revolving around China, and with Brazil's difficulties not capturing nearly as much coverage, the recent China-based IPOs likely suffered from a more profound negative sentiment than ARCE's IPO did.
ARCE is the provider of a complete pedagogical system with technology-enabled features to deliver educational content to private schools in Brazil. Its turnkey curriculum products provide educational content in both printed and digital formats delivered through its platform to improve the learning process.
As of March 31, 2018, its network consisted of 1,140 partner schools, compared to 835 schools as of March 31, 2017, 667 schools as of March 31, 2016 and 377 schools as of March 31, 2015, representing annual growth rates of 36.5%, 25.2% and 76.9%, respectively. Further, it had 405,814 enrolled students across all Brazilian states as of March 31, 2018, compared to 322,031 enrolled students as of March 31, 2017, 265,354 as of March 31, 2016 and 156,011 as of March 31, 2015, representing annual growth rates of 26.0%, 21.4% and 70.1%, respectively.
ARCE employs an asset-light, highly-scalable business model that emphasizes operational efficiency and profitability. It operates through long-term service contracts with private schools. These contracts generally have initial terms that average three years, pursuant to which it provides educational content in printed and digital format to private schools.
Its revenue is driven by the number of enrolled students at each customer using the solutions and the agreed price per student per year. As a result, it benefits from high visibility in net revenue and operating margin. ARCE's annual retention rate in 2016 and 2017 was 95.0%, making its recurring revenue base highly stable.
For the six months that ended June 30, 2018, net revenue jumped by 43% year/year to R$195.10 mln. The increase was mainly due to organic growth through the addition of new partner schools and an increase in up-sales of its solutions, which resulted in a 26% increase in the total number of students enrolled at its partner schools to 405,814. Also, there was a 11.5% increase in the average contractual fees per student that we charge its partner schools, to R$793.8 per student.
For the period, gross margin improved to 78.1% from 74.7%. Cost of sales was R$42.7 mln, an increase of R$8.3 mln, or 24.3% -- lower than its revenue growth -- reflecting benefits from economies of scale.
On the expense side, General & Admin expenses climbed by 56% to R$30.7 mln, driven by increases in corporate personnel costs as the number of employees expanded to 373 from 218 in the year ago period.
Due to the above, ARCE posted an operating profit of R$75.4 mln, up 39% year/year.