Incomplete combustion (due to low compression) will blow grey smoke out the exhaust.

Given the history of this car, get the quote on the replacement engine. Get a quote on having the head rehabbed (valve stems, valves, seats ground, etc).

With the cost of the new engine in mind, have them pull the head. If it's salvageable and the bottom end is still fine, have the head rehabbed. If the bottom end is kaput or the head is ruined, it may be in your best interest to have them swap the engine.

__________________
Current stable:
1995 E320 149K (Nancy)
1983 500SL 120K (SLoL)

Black Sheep:
1985 524TD 167K (TotalDumpster™)

Gone but not forgotten:
1986 300SDL (RIP)
1991 350SD
1991 560SEL
1990 560SEL
1986 500SEL Euro (Rusted to nothing at 47K!)