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Facebook IPO Hype Swells As Growth Decelerates For Site

Demand continues to accelerate for Facebook's (FB - News) huge initial public offering this week even as the social networking giant's growth has decelerated sharply.

For the second time this week Facebook added more shares for sale, now at 421 million. On Tuesday it raised the price range, to $34 to $38 per share.

Facebook will challenge General Motors (GM - News) as the third largest IPO ever. It dwarfs the IPOs of Google (GOOG - News) and Microsoft (MSFT - News). And at its current market value equal to 25 times annual sales, if Apple (AAPL - News) were valued the same it would be worth $3 trillion, instead of its $510 billion valuation.

Stripping away the emotion and hype, the financial performance of Facebook is disconcerting. According to its S-1 filing, revenue fell in the first quarter from the fourth quarter, as did operating income and profit margins.

Slowing Before Launch

Revenue of $1.06 billion grew 45% vs. a year ago, but it was the fifth straight quarter of deceleration. Facebook earned 10 cents a share, down 9% from a year ago. That's down from 18% growth in Q4 and 54% in Q3.

"Facebook is in a period of slowing growth and could currently be at peak profitability," said Rick Summer, senior equity analyst at Morningstar.

The investment research firm is recommending that its customers not buy shares at this time.

"Overall we think Facebook is a tremendous company with a bunch of lofty expectations, but we also think it will be overvalued out of gate," Summer said.

Another red flag surfaced Tuesday when GM said it will curtail ad spending on Facebook due to a lack of perceived value. That highlights concerns that Facebook's basic business model — selling ads — doesn't pay off for its clients.

"It's a nagging issue," said Jed Williams, senior analyst at research firm BIA/Kelsey. "A lot of people question the effectiveness of ads on social media sites.

But ad spending on social networks will rise 26% this year to $4.8 billion, BIA/Kelsey estimates. That includes spending on LinkedIn (LNKD - News), Twitter and others. Spending will approach $10 billion in 2016.

It's unclear if GM's decision will start a trend. For now, Facebook has to show it's worth the return on investment.

"It's a brand new experience for marketers with many variables and a challenge to measure the return on investment," said Williams. "There are not a lot of tools available to measure that right now.

Advertising accounted for 82% of Facebook revenue in 2011, with most of the rest coming through processing fees from its business relationship with online gaming site Zynga (ZNGA - News).

Throughout its S-1 filing Facebook warns numerous times how a slowdown in ad spending would "adversely affect" its business. The company is spending heavily on new ad platforms to increase user engagement. The onus might also fall to marketers to figure out best practices on making their ads more effective.

Despite these concerns expectations are high that Facebook will perform well on its first day of trading, though some question if it will be a great deal for retail investors right away.

"Investing in the Facebook IPO may turn out to be a great investment but, right now, the stock is clearly not a bargain," said Brian Hamilton, CEO of research firm Sageworks.

Facebook's IPO is expected to price Thursday night, with shares debuting Friday.