I created a new c# project and follwed the steps from this tutorial to create a LocalDataCache:
http://www.codeproject.com/KB/database/AdoSyncServicesArticalPKg.aspx?fid
This is solved now.
The problem is that the database.sdf is always copied to the data output directory and would overwrite the database I was working on (manually making changes to test the merge!).
This can be changed by clicking on the sdf file in visual studio and in properties change the value for "Copy to Output Directory" to "Do Not Copy". Then manage the connection string outside of the data directory. The default is Copy If newer which caused the problems!