Shares of Pandora Media (NYSE:P) are down more than 10% in the past few days, as investors lose faith in the music streaming service's growth story. Founded in 2000, the company became popular for being the custodian of the Music Genome Project, an extremely powerful algorithm for music recommendation. However, in the past few months, the company has struggled with fierce competition from Spotify and Apple's (NASDAQ:AAPL) new music streaming service, iTunes Radio. Can Pandora continue growing?


Source: Pandora

In its most recent quarter, Pandora reported a net loss of $0.14 per share, which was a bit higher than the consensus. In terms of top line, the company generated $193.4 million in revenue, representing a 69% increase year over year. Advertising revenue increased 45% year over year to $140.6 million. Subscriptions were particularly strong, as they saw a 94% increase year over year.

It's all about user growth
Although Pandora's growth numbers may look decent enough at first glance, the reality is that the company may need to deliver massive growth in order to sustain its current market capitalization. Pandora, which is expected to grow revenues by 31% in 2015, is trading for more than 30 times forward earnings. Clearly, investors see this company as a high-growth stock, and therefore may pay more importance to user growth than earnings.

In terms of user growth, Pandora's situation could be a bit delicate due to increased levels of competition. In the latest monthly audience report published by Pandora, the company stated it had 77 million active users in May, up from 76 million in April, and 70.8 million a year ago. Clearly, the company is suffering from decelerating user growth. To make matter worse, listener hours rose only 1.7% on a month to month basis. In terms of market share, the company's share of total U.S. radio listening actually declined from 9.28% in April to 9.13% in May.

Pandora's disappointing user growth metrics can be explained by the increase of competition. In particular, Apple is a fierce competitor, especially after acquiring Beats for more than $3 billion in order to improve its streaming radio service.

Beats, which includes both Beats Audio hardware and Beats Music radio service, was founded by rapper Dr. Dre and music industry executive Jimmy Iovine. Beats Music, which was launched in Jan. 2014, has more than 250,000 subscribers. The deal is expected to revamp iTunes Radio, which already has more than 40 million monthly users.

Unfortunately for Pandora, Apple isn't the only big tech player interested in the music streaming space. Google's recent purchase of Songza, a Pandora-like music player focused on anticipatory contextual playlists, is a signal that the search engine giant is very serious about conquering the online music streaming space.

Finding new growth opportunities
As competition increases, Pandora will have to differentiate its service as much as possible in order to continue growing. One way of achieving differentiation is by specializing on a particular market segment, such as in-car integration.

The car industry represents a huge market opportunity for Pandora, as analysts estimate that roughly half of all radio listening happens in the car. The company has put strength in cars in the past few months. As a result, this year 135 car models are expected to be released with Pandora built in. Moreover, more than five million new Pandora users have signed up in the car so far.

Final Foolish takeaway
Pandora needs to deliver massive user growth in order to justify its huge market capitalization. Increasing competition from Apple and Google will make it difficult for Pandora to continue growing, yet it is still possible for the company to deliver better-than-expected growth figures through a well-planned differentiation strategy. The recent emphasis on cars is an example of how Pandora could come up with new ideas to increase user base and revenue.

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Victoria Zhang has no position in any stocks mentioned. The Motley Fool recommends Apple and Pandora Media. The Motley Fool owns shares of Apple and Pandora Media. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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