Also there's chemical solution - after grinding off the loose stuff, coat it with some sort of 'naval jelly' product that dissolves rust in metal surfaces. It's kinda cool, actually makes the metal black. Then paint it with ass-kicking anti rust primer and proceed with patching. welded steel? riveted sheet metal or aluminum? fiberglass? Heck, it's at a location where you can make a mess and do whatever you want. And when you're done consider mudflaps for front wheel wells.

And you can go ahead and paint the entire rocker panel with black undercoat, same as they did on later 123's. It wont detract from appearance of the car. Does not look terminal to me, even through a rubber hammer could probly knock right through. The main support beams are under there next to your brand new muffler system, not the rockers.