I just spent the last 4 hours getting my machine ready for a user group demo; I was trying to get SQL Express setup so that I could do a LINQ to SQL demo; what a painful 4 hours! I will try to document things that I discovered along the way here so that you won't go through the same pain.
In my case, I had VS 2005 and SQL Express installed on the same machine.
These are the steps you need to do to get Server Explorer in VS to talk to SQL Express.
** Each time you make a change, you should be able to restart the SQL Server service. This never worked for me. I had to restart my machine after each change.
Man, we have a lot of work to do. This stuff should just work. No one should need to follow so many steps just to get a connection to a database. I should be able to get samples running right out of the box.