Since the rumors of a merger between Reynolds-American and Lorillard (UNKNOWN:LO.DL) had been swirling for months it wasn't a real surprise when a deal was finally announced last month, but what did raise some eyebrows was the decision to sell the latter's top-selling electronic cigarette brand blu eCig as part of the bargain.
Purchasing it in 2012 for $135 million, Lorillard quickly coaxed blu eCig into the industry-leading brand, generating sales of $230 million in 2013 for the tobacco giant, a nearly four-fold increase in year-over-year sales of electronic cigarette products for the company.
Blu captured 45.8% of the domestic retail electronic cigarette market dollar-wise in December of last year,, benefiting from a national television advertising campaign to build brand awareness, expanding into more than 136,000 retail outlets nationwide, and launching new, lower-cost rechargeable kits that all helped generate strong repeat business.
So when the merger with Reynolds was announced, some were left scratching their heads wondering why Lorillard would willingly give up such a strong brand. Sure, Reynolds had been investing a lot of time and money into its own e-cigarette, Vuse, which enjoyed early success in the test market states of Utah and Colorado, but it seemed it was giving up the bird it had in hand for two it might find in the bush.
Upon closer inspection though, selling blu to Imperial Tobacco Group (NASDAQOTH:IMBBY) for $7.1 billion -- along with regular tobacco brands Kool, Salem, and Winston -- might not have been the crazy decision it first seemed.
Cracks in the blu eCig monolith began appearing right away this year, first as part of industry maturation, and second, the onslaught of new competitors.
The first e-cigarettes to market adopted a look similar to traditional cigarettes, from the long white tube to a faux filter and even a glowing ember. Blu's name itself was derived from the bright blue LED on its tip to indicate when it was "lit."
But as "vaping" caught on -- e-cigarettes don't emit smoke, but rather a vapor from the heating of a liquid -- the industry was quick to evolve to a point where there's a whole new language developing around the trend. No longer are e-cigarettes simply nicotine replacement therapy, but now encompass "vaping" and "tanks," and users take pride in blinging out their "mods" while enjoying flavored juices they drip onto coils.
They're not just e-cigs, but "personal vaping systems," or PVS, that resemble recorders, or that first musical instrument you were introduced to in grade school, only cooler. Now the PVS's are also called "vaporizers," "wands," or "vape pens" and a whole new culture has grown up around the phenomenon. Vape bars are the new cigar lounges without the stench.
Yet the success Lorillard achieved with blu also ensured the other tobacco companies would enter the market as well, along with smaller upstarts. In addition to Reynolds' Vuse brand, Altria, which was late to the game, made up for lost time by purchasing the Green Smoke brand earlier this year and rolling out nationally its new Mark Ten brand of e-cigarettes this past June.
The cumulative effect of all this new competition took an immediate toll on Lorillard's blu. Its e-cigarette revenues dropped 14% in the first quarter to $49 million and plunged another 23% in the second quarter as lower volumes and the introduction of the lower-priced rechargeable kits cut sales, which are proving to be a popular option in e-cigarettes.
Now Nielsen data confirms that blu's fall from grace -- or at least market share -- is accelerating. According to just-released data, Logic Technology Development's brand of electronic cigarettes has moved into the top spot in terms of units with a 24.3% share, toppling Lorillard's blu eCig for the first time. While blu is still leading in dollars, Logic is closing in at No. 2 with a 22.9% share.
What may be more worrisome is that despite initial rosy projections that electronic cigarettes may one day surpass traditional tobacco sales, Nielsen is finding that sales are falling at convenience stores, down 17% for the period ending in June, though Wells Fargo (which forecast e-cigarette sales to hit $10 billion by 2017), contends sales may be moving out of c-stores and into vape shops and other nontraditional outlets.
Still, it suggests that blu's hold on the e-cigarette top spot dollar-wise may be tenuous at best and could be a big reason it found it easy to sign off on selling the brand. If and when the merger goes through, it gets a premium price for what could be a troubled product. Imperial Tobacco, on the other hand, which becomes the fourth-largest cigarette company with its portfolio of cigarettes acquired, electronic or otherwise, may find itself feeling blue with the outcome after all.
Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.