Is Twitter helping to inflate the tech bubble?

A little over six months after the company raised a gigantic round of financing that valued it at close to $4 billion, Twitter is in negotiations to close other massive round, according to a report in the Wall Street Journal (s nws). The latest series could put a value of $7 billion on the real-time information network, the WSJ said. Like its fellow tech stars — LinkedIn (s lnkd), Groupon, Pandora (s p) and others — Twitter is clearly taking advantage of what appears to be a red-hot market for technology stocks. But can it generate enough revenue to justify that kind of lofty valuation?

LinkedIn was the first to crack the public markets in the latest round of stock offerings, with an IPO in January that valued the company at $4 billion. But it was Groupon that really set the markets on fire, with a controversial filing that could value the four-year-old company (which turned down a rumored $6-billion acquisition offer from Google (s goog)) at more than $20 billion. Then came Pandora (s p), which went public last month at a valuation of close to $3 billion, despite the fact that the company isn’t profitable — and may never become so.

Facebook has also been doing its part to push tech-company valuations up, although it has done so from within the private markets, by raising more than $2 billion in funding through a Goldman Sachs-led syndicate (s gs) and other entities such as Digital Sky Technologies. Those deals and the trading in secondary shares on exchanges such as SecondMarket have given the company a market value estimated at $60 billion. So far, Twitter has also avoided the public markets in favor of the traditional venture-funding route.

While Twitter may not be as clearly unprofitable as Pandora — whose business model has been criticized because its costs continue to increase as it grows — the company has yet to prove it can generate enough revenue to justify a $7-billion valuation. Although the company’s actual finances are unknown, estimates from third parties such as eMarketer suggest Twitter is likely to produce $150 million in revenue this year from its core advertising features: namely, Promoted Tweets and Promoted Trends. While that figure is expected to continue growing next year, will it do so at a rate that makes $7 billion look reasonable?

According to several recent reports, Twitter is expected to introduce more conventional ads directly into the streams of its users soon, but whether this is going to be received positively by the Twitter community remains to be seen. Many users have said in the past they wouldn’t tolerate ads in their feeds (although the company could potentially start charging users to remove those ads and generate revenue that way). The company is also planning to offer an automated system that would allow businesses to create and promote their own ads.

The biggest challenge for Twitter when it comes to generating revenue and/or profits — as we’ve argued in the past — is that the company is effectively a media entity, whether it wants to be or not. It’s a real-time publishing and information network, which means people see it primarily as a utility of sorts. Adding revenue-generating mechanisms to that kind of service isn’t easy to do, since users often see these mechanisms as intrusive. But traditional forms of banner-style advertising, the main tool for most media companies and publishers, likely aren’t going to produce much bang for the buck.

The company’s soaring valuation, meanwhile, puts its recent battle with competitors such as Bill Gross’s UberMedia in context, since that puts even more pressure on Twitter to control every aspect of its ecosystem — in the hopes that it can come up with a business model that will justify its multibillion-dollar market value. Those moves against UberMedia and others, meanwhile, appear to have triggered an inquiry by the Federal Trade Commission into Twitter’s practices, according to one recent report, although it’s not clear whether that will result in an official investigation. Welcome to the big leagues, Twitter.

Post and thumbnail photos courtesy of Flickr user Gabrie Coletti