The Wall Street Journal is reporting that Microsoft is in talks to buy 5% of Facebook for $300-500 million. Facebook is courting multiple investors and is asking for a valuation of at least $10 billion.

Google is apparently also in the running, though Google has a lot less cash saved up than Microsoft does.

Must be nice to be Mark Zuckerberg.

Facebook is growing quickly. It not boasts 40 million users, up from 9 million one year ago.

But the funny thing is that the Journal reports that Facebook has chosen the investment approach, because their business model can’t sustain an IPO. The valuation isn’t based on actual earnings or profit. It’s estimated that Facebook has earned the majority of its $60 to $90 million (with no profit) in annual revenue from an advertising deal with Microsoft and that this year it will have a profit of $30 million on revenue of $150 million.

That’s a multiple of 300x profit, which is a bit exagerrated, particularly if you take into account that the payments from Microsoft are effectively a subsidy to create a relationship with Facebook. Although social networking sites like Facebook have huge audiences, most of their members don’t want to see ads. Their click-through rate is relatively low.

But the valuation is more about the clash of the Titans — Google vs. Microsoft — and the fight for the future of the Internet than it is about Facebook per se.

The Journal also has an interesting “where are they now” study of GeoCities, a social networking site that was the Facebook of its day. In August 1998, GeoCities was the 3rd most visited site on the web, and Yahoo bought the company in 2000 for $4.7 billion. But GeoCities failed to update its technology quickly enough so that less than a decade later, the site and its technology are obsolete. Apparently, Yahoo was more focused on building traffic than on improving the service, which meant that Facebook, YouTube and MySpace were soon able to dominate the social networking space.

As the Journal points out, of the top 20 most visited sites in 2003, only 9 still occupy market-leading positions. Innovation — and finding a viable business model — are the keys to staying relevant.

$500 million should go a long way towards making that possible.