It's dropped a valve. Almost certainly will have damaged the cylinder head, and reasonable chance the piston too. The bottom end could be rebuilt, but actually simpler and easier to slot in a new engine.
This sounds like a great project car - especially if you were planning an engine transplant (KV6?), but even if not, then as an engine swap, you'll learn loads about how these cars are put together.
I agree, it's a lot of work to get the engine out and bolt in a new one, but this isn't actually difficult stuff (as I've discovered).
Go into this open-eyed, aware of the pitfalls and see the opportunities. No, this project doesn't make any economic sense. But it could be a lot of fun! I've really enjoyed Project Shed so far - and that's inspite of the car fighting practically every step of the way!
If I do go down the route of replacement engine, Im assuming I can only use VVC engines from the MK1's due to the MEM's version on the ECU - Am I on the right lines?
You can fit a later VVC engine - in fact, any VVC engine. You just need to swap over the relevant ancillaries. Or you could convert to MEMS3 - which as you know already, can be remapped
![Smile :)](./images/smilies/icon_e_smile.gif)
To change to MEMS3 requires a fair bit of wiring (Matt Parker is now a well-known expert at doing this), but it's do-able. As, of course, is swapping over the entire harness to MY2000/Mk1 TF spec
Go on, you know you want to
![Wink ;)](./images/smilies/icon_e_wink.gif)