I wanted to use Web Setup Project to deploy WAP project in the same way as VS 2003 web peroject was used.
In VS 2003 docs it is specified: to select the Web Application folder ...,then Select the Primary Output and Content Files groups from the list, then click OK.
However for WAP project when deployed, it copied all DLLs(the primary output) to the root of Web application, not to the BIN sub-folder.
It seems that workaround is quite simple- add "Primary Output" to BIN sub-folder (have not test it yet).

Is it a bug or undocumented feature?

By the way, VS 2005 has very little documentation about Web Setup Project.