Despite some progress that music-streaming leader Spotify (NYSE:SPOT) has made with profitability, Evercore remains skeptical about the company's ability to generate sustainable profits. Analyst Benjamin Black downgraded his rating on Spotify shares this week, from in-line (equivalent to a hold) to underperform (equivalent to a sell). Black left his price target unchanged at $115 but issued the downgrade partially in response to Spotify's stock rallying over the past couple of months.

Shares have flirted with $160 in recent days, and the analyst believes the risk/reward profile is now in favor of short-sellers.

Interior of Spotify headquarters, with person talking to receptionist behind a desk

Image source: Spotify.

Improved margins are "a pipe dream"

As a pure play on music streaming, Spotify will find itself at a disadvantage as it competes with tech giants that offer music-streaming services as a tangential business. Apple (NASDAQ:AAPL) is Spotify's primary competitor, and Apple Music hit 60 million subscribers last summer. The Mac maker has not provided any updates regarding the service's subscriber base since, and Spotify had 113 million subscribers as of the third quarter. The services compete at the same price points, limiting either company's pricing power. is also increasingly trying to grow its music-streaming business, recently adding a free, ad-supported tier, as well as a high-fidelity plan.

"For Spotify, material margin expansion likely remains a pipe dream, as rivals operate streaming music services at a loss to the benefit of broader ecosystems and labels act as an oligopoly," Black wrote in a research note to investors. "We believe the stock's run from lows has been driven by increasing confidence that a new agreement with labels will improve visibility to the path to gross margin expansion, as called for in current consensus estimates."

Any new agreements with record labels will prove to be disappointing, in the analyst's view. Spotify renegotiates its licensing agreements with record labels every few years, which has occasionally resulted in lower costs and improved margins. While the shift to streaming is driving a sustained renaissance for the global music industry, a trend that is expected to continue for the foreseeable future, Black believes that the streaming industry will remain largely unprofitable.

The analyst also downplays the potential of Spotify for Artists, which is part of Spotify's broader "two-sided marketplace" strategy that hopes to capitalize on directly connecting fans with artists. Since going public, the Swedish company has been talking up that strategy, which has the potential to improve margins. However, Black thinks that Spotify for Artists will only pay off if consumers meaningfully change listening habits.

It's worth remembering that Apple Music Connect, that service's similar effort to allow artists to engage with fans directly, was shut down over a year ago due to a lack of popularity and engagement. Apple finally launched Apple Music for Artists, a similar set of analytics tools, in August 2019 -- for free.

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