I agree that it is watered down now.
The championship scores from 1996 (the year before DI and DII were implemented) are as follows:
1A DCA 51, St. Benedict 3
2A Knox Webb 27, Goodpasture 20
3A Melrose 32, Tyner 12
4A Pearl-Cohn 18, Knox Halls 14
5A Brentwood Ady 28, Jefferson Co. 7
Brentwood Academy beat Riverdale in 1995. In 1996, 1A and 2A championship games were all private. Five out of 10 (50%) teams were private; three out of five (60%) champions were private. Currently, private schools make up approximately 14% of the high schools in TN (I don't know what it was in 1996, but I would guess that it was similar to what it is now). In 1996, schools making up 14% of the population made up 50% of the teams competing for the state championship and made up 60% of the football state champions. I would assume that other sports had similar percentages.
So yes, public schools competed, but I think it showed that private schools had an advantage.