6. Fair value of financial instruments

Initial recognition and measurement

Financial instruments are recognized when the Company becomes a party to the transaction. Initial measurements are at cost, which includes transaction costs.

Risk management

The Company manages its exposure to currency exchange, translation, interest rate, customer concentration, credit and equity price and liquidity risks as discussed below.

Currency exchange risk

The Company is subject to currency exchange risk because it purchases inventories that it is required to settle in other currencies, primarily the euro and U.S. dollar. The Company has used forward contracts in order to limit its exposure in these transactions to fluctuations in exchange rates between the South African rand ("ZAR"), on the one hand, and the U.S. dollar and the euro, on the other hand.

Translation risk

Translation risk relates to the risk that the Company's results of operations will vary significantly as the U.S. dollar is its reporting currency, but it earns most of its revenues and incurs most of its expenses in ZAR. The U.S. dollar to ZAR exchange rate has fluctuated significantly over the past three years. As exchange rates are outside the Company's control, there can be no assurance that future fluctuations will not adversely affect the Company's results of operations and financial condition.

Interest rate risk

As a result of its normal borrowing and lending activities, the Company's operating results are exposed to fluctuations in interest rates, which it manages primarily through regular financing activities. The Company generally maintains limited investments in cash equivalents and held to maturity investments and has occasionally invested in marketable securities.

Credit risk

Credit risk relates to the risk of loss that the Company would incur as a result of non-performance by counterparties. The Company maintains credit risk policies with regard to its counterparties to minimize overall credit risk. These policies include an evaluation of a potential counterparty's financial condition, credit rating, and other credit criteria and risk mitigation tools as the Company's management deems appropriate.

With respect to credit risk on financial instruments, the Company maintains a policy of entering into such transactions only with South African and European financial institutions that have a credit rating of "B" (or its equivalent) or better, as determined by credit rating agencies such as Standard & Poor's, Moody's and Fitch Ratings.

Microlending credit risk

The Company is exposed to credit risk in its microlending activities, which provide unsecured short-term loans to qualifying customers. The Company manages this risk by performing an affordability test for each prospective customer and assigning a "creditworthiness score", which takes into account a variety of factors such as other debts and total expenditures on normal household and lifestyle expenses.

Equity price and liquidity risk

Equity price risk relates to the risk of loss that the Company would incur as a result of the volatility in the exchange-traded price of equity securities that it holds and the risk that it may not be able to liquidate these securities. The market price of these securities may fluctuate for a variety of reasons and, consequently, the amount that the Company may obtain in a subsequent sale of these securities may significantly differ from the reported market value.

Liquidity risk relates to the risk of loss that the Company would incur as a result of the lack of liquidity on the exchange on which these securities are listed. The Company may not be able to sell some or all of these securities at one time, or over an extended period of time without influencing the exchange traded price, or at all.

Financial instruments

The following section describes the valuation methodologies the Company uses to measure its significant financial assets and liabilities at fair value.

In general, and where applicable, the Company uses quoted prices in active markets for identical assets or liabilities to determine fair value. This pricing methodology would apply to Level 1 investments. If quoted prices in active markets for identical assets or liabilities are not available to determine fair value, then the Company uses quoted prices for similar assets and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. These investments would be included in Level 2 investments. In circumstances in which inputs are generally unobservable, values typically reflect management's estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques. Investments valued using such techniques are included in Level 3 investments.

Asset measured at fair value using significant unobservable inputs – investment in Cell C

The Company's Level 3 asset represents an investment of 75,000,000 class "A" shares in Cell C, a leading mobile telecoms provider in South Africa. The Company has developed an adjusted EV/EBITDA multiple valuation model in order to determine the fair value of its investment in the Cell C shares. The primary inputs to the valuation model as of December 31, 2018, are unchanged from June 30, 2018, except for the EBITDA multiple. The primary inputs to the valuation model are Cell C's annualized adjusted EBITDA for the 11 months ended June 30, 2018, of ZAR 3.9 billion ($270.9 million, translated at exchange rates applicable as of December 31, 2018), an EBITDA multiple of 6.32; Cell C's net external debt of ZAR 8.8 billion ($611.4 million, translated at exchange rates applicable as of December 31, 2018); and a marketability discount of 10% as Cell C is not currently listed, but has publicly stated its intention to list. The EBITDA multiple was determined based on an analysis of Cell C's peer group, which comprises eight African and emerging market mobile telecommunications operators. The fair value of Cell C utilizing the adjusted EV/EBITDA valuation model developed by the Company is sensitive to the following inputs: (i) the Company's determination of adjusted EBITDA; (ii) the EBITDA multiple used; and (iii) the marketability discount used. Utilization of different inputs, or changes to these inputs, may result in significantly higher or lower fair value measurement.

The following table presents the impact of a 0.50 increase and 0.50 decrease to the EBITDA multiple used in the Cell C valuation on the December 31, 2018, carrying value of the Company's Cell C investment (all amounts translated at exchange rates applicable as of December 31, 2018):


	Sensitivity for
	fair value of
	Cell C investment
EBITDA multiple of 5.82 times	130,729
EBITDA multiple of 6.32 times	149,058
EBITDA multiple of 6.82 times	167,386

The fair value of the Cell C shares as of December 31, 2018, represented approximately 14% of the Company's total assets, including these shares. The Company expects to hold these shares for an extended period of time and it is not concerned with short-term equity price volatility with respect to these shares provided that the underlying business, economic and management characteristics of the company remain sound.

Liability measured at fair value using significant unobservable inputs – DNI contingent consideration

The salient terms of the Company's investment in DNI is described in Note 3 to the Company's audited consolidated financial statements included in its Annual Report on Form 10-K for the year ended June 30, 2018. Under the terms of its subscription agreements with DNI, the Company has agreed to pay to DNI an additional amount of up to ZAR 400.0 million ($27.8 million, translated at exchange rates applicable as of December 31, 2018), in cash, subject to the achievement of certain performance targets by DNI. The Company expects to pay the additional amount during the first quarter of the year ended June 30, 2020, and has recorded an amount of ZAR 385.7 million ($26.8 million) and ZAR 373.6 million ($27.2 million), in other payables in its unaudited condensed consolidated balance sheet as of December 31, 2018, and in long-term liabilities as of June 30, 2018, respectively, which amount represents the present value of the ZAR 400.0 million to be paid (amounts translated at exchange rates applicable as of December 31, 2018 and June 30, 2018, respectively).

The present value of ZAR 385.7 million has been calculated using the following assumptions (a) the maximum additional amount of ZAR 400.0 million will be paid on August 1, 2019 and (b) an interest rate of 6.3 % (the rate used to calculate interest earned by the Company on its surplus South African funds) has been used to discount the ZAR 400.0 million to its present value as of December 31, 2018. Utilization of different inputs, or changes to these inputs, may result in significantly higher or lower fair value measurement.

Derivative transactions - Foreign exchange contracts

As part of the Company's risk management strategy, the Company enters into derivative transactions to mitigate exposures to foreign currencies using foreign exchange contracts. These foreign exchange contracts are over-the-counter derivative transactions. Substantially all of the Company's derivative exposures are with counterparties that have long-term credit ratings of "B" (or equivalent) or better. The Company uses quoted prices in active markets for similar assets and liabilities to determine fair value (Level 2). The Company has no derivatives that require fair value measurement under Level 1 or 3 of the fair value hierarchy.

The Company's outstanding foreign exchange contracts are as follows as of December 31, 2018:


		Fair market
Notional amount	Strike price	value price	Maturity
USD 420,000	ZAR 15.3801	ZAR 14.4210	January 25, 2019
USD 140,000	ZAR 15.4386	ZAR 14.4704	February 22, 2019
USD 420,000	ZAR 15.4939	ZAR 14.5165	March 20, 2019
USD 420,000	ZAR 15.5704	ZAR 14.5842	April 26, 2019

The Company had no outstanding foreign exchange contracts as of June 30, 2018.

The following table presents the Company's assets and liabilities measured at fair value on a recurring basis as of December 31, 2018, according to the fair value hierarchy:


		Quoted price in		Significant
		active markets		other		Significant
		for identical		observable		unobservable
		assets		inputs		inputs
		(Level 1)		(Level 2)		(Level 3)		Total
Assets
Investment in Cell C	$	-	$	-	$	149,058	$	149,058
Related to insurance business:
Cash, cash equivalents and restricted cash
(included in other long-term assets)		593		-		-		593
Fixed maturity investments (included in
cash and cash equivalents)		8,319		-		-		8,319
Other		-		18		-		18
Total assets at fair value	$	8,912	$	18	$	149,058	$	157,988
Liabilities
DNI contingent consideration	$	-	$	-	$	26,790	$	26,790
Foreign exchange contracts		-		95		-		95
Total liabilities at fair value	$	-	$	95	$	26,790	$	26,885

The following table presents the Company's assets and liabilities measured at fair value on a recurring basis as of June 30, 2018, according to the fair value hierarchy:


		Quoted price in		Significant
		active markets		other		Significant
		for identical		observable		unobservable
		assets		inputs		inputs
		(Level 1)		(Level 2)		(Level 3)		Total
Assets
Investment in Cell C	$	-	$	-	$	172,948	$	172,948
Related to insurance business:
Cash and cash equivalents (included in other
long-term assets)		610		-		-		610
Fixed maturity investments (included in
cash and cash equivalents)		8,304		-		-		8,304
Other		-		18		-		18
Total assets at fair value	$	8,914	$	18	$	172,948	$	181,880

Liabilities
DNI contingent consideration	$	-	$	-	$	27,222	$	27,222
Total liabilities at fair value	$	-	$	-	$	27,222	$	27,222

There have been no transfers in or out of Level 3 during the three and six months ended December 31 2018 and 2017, respectively.

Summarized below is the movement in the carrying value of assets and liabilities measured at fair value on a recurring basis, and categorized within Level 3, during the six months ended December 31, 2018:


		Carrying value
Assets
Balance as at June 30, 2018	$	172,948
Loss on fair value re-measurements		(15,836	)
Foreign currency adjustment⁽¹⁾		(8,054	)
Balance as of December 31, 2018	$	149,058
Liabilities
Balance as at June 30, 2018	$	27,222
Accretion of interest		835
Foreign currency adjustment⁽¹⁾		(1,267	)
Balance as of December 31, 2018	$	26,790

(1) The foreign currency adjustment represents the effects of the fluctuations of the South African rand and the U.S. dollar on the carrying value.


		Carrying value
Assets
Acquisition of investment in Cell C	$	151,003
Foreign currency adjustment⁽¹⁾		10,692
Balance as of December 31, 2017	$	161,695

(1) The foreign currency adjustment represents the effects of the fluctuations of the South African rand and the U.S. dollar on the carrying value.

Assets measured at fair value on a nonrecurring basis

We measure equity investments without readily determinable fair values on a nonrecurring basis. The fair values of these investments are determined based on valuation techniques using the best information available, and may include quoted market prices, market comparables, and discounted cash flow projections.