Spotify just proved that the streaming music business is a like a black hole — and investors might not see it until it’s too late (AAPL, GOOGL, AMZN)

• Spotify released its financial results Wednesday as part of the paperwork it filed to become a public company.
• The results show just how difficult the streaming business is, even for the market leader.
• Investors shouldn’t expect Spotify to ever become a big money maker.

If you hadn’t figured this out already, the streaming music business is a terrible one to be in.

That’s the chief takeaway from the financial paperwork Spotify filed Wednesday in advance of becoming a public company. Despite dominating the subscription music market, the company generates relatively little money per user, has to give away nearly all the money it generates to the big recording companies, and continues to rack up losses.

And, as the company warned potential investors, things may never get much better.

“There can be no guarantee as to when we will eventually reach profitability, if at all,” the company said in it regulatory filings.

It’s been clear from the years and years worth of losses Pandora has posted that streaming music can be a tough business. But one would have hoped that Spotify would be in a much better position. After all, by some measures, the company has been wildly successful.

Spotify dominates the streaming music business

Not too long ago, there were plenty of doubters around who wondered if consumers would ever give up buying songs and albums in favor of paying a monthly subscription. Now, subscriptions generate far more money for the music industry than paid downloads, thanks in no small part to Spotify.

The company has 159 million monthly active users from around the world, 71 million of which pay a monthly subscription fee to use its service. Despite facing off against some of the biggest and most powerful companies in the world, including Apple, Google, and Amazon, Spotify has more than held its own. Its number of paying subscribers is about double that of Apple Music, the no. 2 player in the streaming music market.

Even though it’s already huge, Spotify continues to grow rapidly. Its number of monthly active users jumped 29% last year. And as impressive as that growth is, Spotify is having even more success convincing users to pay for its service. Its number of premium subscribers grew 46% in 2017.

All that growth has helped lead to improving financial results. The company’s sales jumped 39%.

Thanks to contracts it renegotiated with the major record labels last year, Spotify now gets to keep more of the money it takes in from subscribers and advertisers, helping it improve its bottom line. While its operating loss increased last year, the company actually shrunk that loss significantly as a portion of its revenue. And Spotify has generated free cash flow — the amount of cash yielded by a company’s operations less expenditures on long-term goods and assets like property and equipment — for the last two years.

But it hands over nearly all its revenue to the record labels

It sounds like everything is moving in the right direction, right? So what’s not to like?

Well, as impressively as Spotify has performed and as big of an impact as it’s had on the music industry, its business is still nothing to get excited about. Even with the renegotiated contracts, Spotify still has to pay out huge royalty fees to the big record labels.

After paying out those fees and a few assorted other costs directly related to providing its streaming service, the company is left with only around 21 cents of every dollar it takes in. And that’s before it has to pay for advertising or research and development.

Those costs are a big reason why Spotify doesn’t seem to have ever posted a full-year profit. Last year, for example, it lost about $1.5 billion on $5 billion in sales. Even if you back out a big one-time financing expense it recorded and some much smaller finance-related income, the company would still have lost $461 million on its operations alone.

If you exclude certain non-cash charges, as Wall Street analysts are fond of doing, Spotify’s operations actually generated money. Just not a whole lot. Last year, the company produced $133 million in free cash flow, up from $89 million the year before.

To put those numbers in perspective, Spotify generated about 84 cents of cash for every monthly active user it had last year, up from about 72 cents the year before. All those $10 a month subscriptions it sells and ads it posts on its free service? They added up to less than a $1 per user — for the whole year.

The company is hemmed in by user expectations and deep pocketed rivals

And you shouldn’t expect Spotify to ever generate lots of cash, even it it does eventually become profitable.

Here’s why.

The appeal to consumers of music streaming services like Spotify is that they offer access to practically all recorded music for a relatively affordable price.

As such, the services are completely dependent on the music labels to grant them access to their libraries — and they have to pay whatever the labels think is fair. Right now, that’s somewhere in the neighborhood of 80 cents of every dollar — but that price could up.

Spotify could try to pull a Netflix and publish more artists on its own, rather than having to license all the songs and albums from the big music labels.

But the Netflix model won’t translate to Spotify.

That’s because unlike Netflix, Spotify couldn’t get away with offering a more tailored selection of content. Consumers expect access to a universe of music when they subscribe to a streaming service. It’s different than TV, which is more hit-driven.

If Spotify goes narrow, it becomes a nice-to-have service for consumers, instead of the must-have universal music service that consumers will gladly let Apple, Google or Amazon charge their credit cards for every month.

And that points to the fundamental “catch-22” problem in the streaming music business.

You can’t go narrow. But if you go broad there’s little to differentiate the streaming services. They all basically offer the same proposition. Sure, the apps consumers use to access them are different, and some offer better features than others, but consumers basically get the same thing from each one for the same basic price. That close competition limits Spotify’s ability to raise prices or differentiate its service.

And while music is Spotify’s entire business, it’s a just side hustle for Spotify’s bigger rivals. Apple Music helps sell iPhones. For Amazon, music helps make its Prime subscription service more attractive. Those companies can afford to run their music businesses at breakeven or even at a loss, because they’re making their money elsewhere. Spotify doesn’t have that luxury — but its sales and costs will likely be influenced by such factors.

So don’t get too excited about Spotify’s impending debut on the public markets. Yes, it dominates streaming music. But that position isn’t worth a whole lot.