Matt Cutts: We really don’t care that much. We’re pretty good that anytime we see white space, we’ll separate stuff and we can ignore white space. It really doesn’t cause us a lot of harm either way.
The only thing to really pay attention to is where I have seen some really sneaky people who will try to do hidden text or whatever and they’ll start off their HTML with like 60 new lines. So whenever you view source code you’re like, “Man, it’s blank, there is no source. Whoa dude you just blew my mind.” And anybody who is savvy is like, “or I can use the scroll bar and see what’s down here.”
So I would just use whatever white space is reasonable for you. I think clean HTML with some nice indentations and all that sort of stuff looks good. It makes your site more maintainable. It makes it easy to upgrade and see what’s going on with your source.
And Google does a very good job about finding separators and breaking it. So don’t make one word for every 200 blank lines, but otherwise as long as you’re doing normal, reasonable stuff I wouldn’t worry about it that much. I’d do whatever is best for you as you are as you’re maintaining your site.