Lo Blu
blu was a huge growth leader for Lorillard before the Reynolds American merger. Image: Lorillard.

Electronic cigarettes have become increasingly popular as an alternative to traditional tobacco cigarettes, and among the new brands in the industry, blu electronic cigarettes in particular got a solid head start over its rivals. That attracted the attention of Lorillard, which bought blu eCigs in 2012. Yet when Lorillard merged with Reynolds American (NYSE:RAI), the blu electronic cigarettes unit was sold to Imperial Tobacco (NASDAQOTH:IMBBY) as part of a larger $7.1 billion deal that included traditional cigarette brands Kool, Salem, and Winston. Let's take a closer look at why Lorillard and Reynolds American made that decision and how it has affected the prospects for blu eCigs going forward.

How blu became an industry leader
Lorillard was instrumental in identifying the e-cigarette market as a potential high-growth prospect. Seeing the challenges of a long-term decline in traditional cigarette volumes, electronic cigarettes had the potential to address some of the health concerns with tobacco while also offering a new and different experience that could appeal to a new generation of potential smokers. Thanks to Lorillard's efforts, blu nearly quadrupled its sales of e-cigarettes in 2013, generating $230 million in sales. Blu also became the early leader in the fast-growing industry, with nearly half of the domestic retail electronic cigarette market as measured by dollar volume by the end of 2013.

As a result, it came as a shock to many investors when Reynolds said that it would divest blu as part of the Lorillard merger. Instead, Reynolds decided to stick with its Vuse brand. As CEO Susan Cameron described it, Vuse "offers superior technology and has received very positive early results in its national rollout," and that was enough to justify the decision in her mind.

Blu and Imperial Tobacco
Since Imperial took over blu eCigs following the Reynolds American-Lorillard merger, many feared that the brand would lose out to products from Vuse and Altria's (NYSE:MO) MarkTen lines. Imperial has only recently completed the integration of the acquired units into its own operations, and early signs did show some deteriorating market-share figures as Vuse and MarkTen gained traction.

Imperial said in its financial report in November that blu was gaining traction in its home U.K. market. It announced plans to strengthen the brand's position in the U.S. as well, with CEO Alison Cooper highlighting blu as one of the emphasis areas in Imperial's overall U.S. marketing focus for the near future.

Not everyone shares Imperial's optimism. Several analysts note that Imperial faces an uphill battle in general as it aims to secure its position as the new No. 3 player in the U.S. tobacco market. Both Altria and Reynolds American have long histories with U.S. retailers and other distribution channels, and part of blu's success under Lorillard was its ability to tap into those lucrative networks. Imperial will try to build up the relationships that Reynolds American and Altria already have, but one analyst has said that the majority of retailers see Imperial losing market share both in tobacco and in electronic cigarettes. Fierce competition in the space shows few signs of letting up anytime soon.

Blu electronic cigarettes are still an important player in the e-cigarette market, but they don't have the same clear leadership role that they once had. Given the competition that Altria and Reynolds American brought to the industry, the decision to sell blu seems to have been prescient. Now, it'll be up to Imperial to see whether it can restore blu's leadership position in the U.S. and make it a true international force in the U.K. and other markets going forward.

Dan Caplinger 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.