I clearly indicated that the key controls the timing.----It might run if flywheel is just slightly out of position.----And no you cannot find the sheared key with a timing light either.
Look into issues with water diverters.----There are 3 on each side.----They guide water around for proper cooling.-----If 1 is out of position it can block water flow.
Just looked at some similar lower cowlings.----Plenty of places for air to get in.-----What is the motor doing / not doing that leads you to believe there is an air restriction ???
Water in the fuel ?-----Oil injection tested and working properly ?----Start with a compression test.----Post the numbers.-----Then do a spark check as it sounds like it is running on 3 of 4 cylinders.-----
It was clearly mentioned ( post #9 ) that the 7.5 HP of 56 can have a gearcase of a 6 HP up to 79 fitted.-----There was no mention of 1995 model 6 HP !!
That leakage may be normal.-----Perhaps caused by it running on 1 cylinder.----Post compression test results.-----Does spark jump a gap of 5/16" or more on both leads ?-----New diaphragm on the fuel pump would be my fix.
Might just need breaker points cleaned.-----Post some information.-----Do a compression test.-----Does spark jump a gap of 1/4" or more.------It will need a new water pump impeller.-----A Mercury dealer will help with parts.------Not hard to find.