I’m experimenting with Windows XP Embedded at the moment and the development studio it installs relies on the MSDE (assuming you don’t already have a SQL Server). I’d set it up so the MSDE based component database was on a virtual machine, and was running the Target Designer on my local “real” machine. For some reason the Target Designer on the local machine wouldn’t talk to the database on the back end.
It’s obvious why (after a little thinking!) the MSDE denies remote access by default! To change that behaviour, run the “SQL Server Network Utility” (SVRNETCN.EXE) and add TCP/IP to the enabled list. Sorted.